By Simon Grey, on April 8th, 2011
Fisher continued his rebuke of the $600 billion program that is set to end in the summer by saying “it may well be that we should consider curtailing what remains” of the program commonly referred to as QE2.
The Dallas Fed president is a voting member of the interest rate setting Federal Open Market Committee, and he has for a number of months been a steady critic of efforts by the Fed to stimulate growth by buying longer-dated government bonds. Fisher believes the economy simply doesn’t need the support right now, and fears the extra liquidity the central bank is providing may be setting off a new round of financial market imbalances as well as creating a future inflation surge.
I think at this point it’s pretty obvious that QE2 was not only a complete failure but also very destructive. Thus, I do not see how there is any “maybe” when it comes to curtailing QE2. The only thing this latest round of inflation has succeeded in doing is (surprise) inflating the currency. The proverbial animal spirits were not stimulated enough to go out and consume or even produce. The country is not materially better off, or even more productive once you eliminate debt-fueled government spending from the official GDP metric.
As such, definitive language is called for. We should curtail QE2. We should, if possible, “repeal” QE2. This round of inflation has not done anything, save making the necessities of life more expensive. And it is destroying savings in the process. We need to make it stop.
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By B.P.T., on April 8th, 2011
At 10:00 AM EDT, the Wholesale Trade report will be released for February, showing inventory levels for wholesalers in the United States.
By The Gold Report, on April 7th, 2011
McNicoll, Lewis & Vlak Investment Analyst Imaru (Ima) Casanova specializes in “under-covered” and turnaround companies in the resource sector. In this exclusive interview with The Gold Report, Ima describes several situations that fit her investment parameters, including the unique field of royalty companies.
The Gold Report: Thanks for joining us this morning. Before we get into specifics, please give us a little background on McNicoll, Lewis & Vlak LLC. (MLV) and its participation in the resource investment sector.
Imaru Casanova: MLV is a relatively new full-service investment bank/broker-dealer in New York. We’ve been around for about a year, focusing on capital-intensive industries—namely natural resources, mining, oil and gas and healthcare. Currently, we cover about 40 companies. We did 25 At-the-Market (ATM) issuances in the last 12 months. ATMs are becoming a huge segment of shelf registration takedowns. About 22% of all the U.S. shelf takedowns last year across all sectors were ATMs. Our philosophy on research is to provide very in-depth coverage and expose those ideas to fundamental institutional investors.
TGR: Could you explain a little more about how ATM works for people who aren’t familiar with it?
IC: In a very simplified way, companies can issue stock at an opportune time for them under a shelf registration. So, a company might file a US$100 million ATM with MLV under a shelf registration. When the issuer and MLV decide that it’s a good opportunity to issue stock, the stock is issued in the open market. The goal is to minimize the disruption to the share price compared to a traditional equity raise. And the costs to the issuer are lower, which, obviously, translates into better value for shareholders.
TGR: Are you looking at mining and metals specifically?
IC: We have other analysts covering the other sectors at MLV. I’m the Metals and Mining analyst. Traditionally, I have looked at precious metals names; but now, I’m also looking at some names with copper exposure. Primarily, my approach has been to provide research on relatively under-covered names—names that don’t have a lot of analyst coverage out there that I think can really add value to the institutional shareholder base by providing research that they’re not getting elsewhere.
TGR: Let’s talk about royalty companies. This is probably an area that most investors know little about because there aren’t many of them out there. Can you explain what these companies do and why you think this is an attractive area for investors?
IC: You’re right, royalty companies aren’t a very well-known area. One example is Royal Gold Inc. (NASDAQ:RGLD; TSX:RGL), which I believe is a very misunderstood company. I think most investors don’t understand the business model. Royalty companies enjoy many significant benefits. One of the most important benefits is that by owning this stock, investors get exposure to a diversified portfolio of mining projects, including some of the highest-quality projects operated by many of the major producers. They also get reserve and resource growth at no cost to the company, which is a significant benefit.
Generally, the majority of these royalty deals don’t have production caps. If Royal Gold acquires a 2% royalty on a project, it doesn’t need to contribute any capital. So, basically, it’s obtaining the growth without having to pay for that growth, which is a huge benefit. The royalty on Goldcorp Inc.’s (TSX:G; NYSE:GG) Peñasquito project is a great example of how Royal Gold benefited from a very significant reserve increase without having to spend a penny.
Another key differentiation is protection against operating-cost increases, which all but guarantees expanded margins in a rising commodity price environment. This is not always true for the producers. So, the royalty structure is a great way to get the optionality that comes with owning a mining name versus physical gold or an ETF. I’ve always talked about it as being sort of a middle ground—a hybrid between an ETF and a producer—because investors get the lower risk profile from the cost-increase protection, as well as the organic growth potential they don’t get if they own bullion or an ETF.
TGR: So, by owning a royalty company, investors end up with something like a closed-end mutual fund?
IC: You can look at it that way, except the interests are not equity interests. Basically, the company owns portions of the production of numerous projects operated by many different publicly listed miners; so, investors get exposure to all those equities via one single stock.
TGR: You wrote a very detailed research report on Royal Gold last October that shows quite a large portfolio of royalty interests. Most are fairly small percentages, but they do add up. So how does Royal Gold and/or other royalty companies acquire these interests? What do they pay for them if there’s any general rule of thumb?
IC: I did a lot of work in trying to figure out how much Royal Gold was paying per ounce, and it’s related to the gold price. In higher-priced environments, obviously, it’s paying more. But, ultimately, I found the company’s cost to be very competitive compared to other acquisitions. My report includes a table that summarizes Royal Gold’s acquisition history, which includes almost 20 transactions starting as early as January 1998.
Many of its royalties come from a transaction the company did with Barrick Gold Corporation (TSX:ABX; NYSE:ABX) in October 2008 when it bought Barrick’s portfolio of royalties. Many more also came from its acquisition of International Royalty Corporation in February 2010. Most recently, the company did the Mt. Milligan transaction with Thompson Creek Metals Company Inc. (TSX:TCM; NYSE:TC), which was announced in July 2010 and, actually, is one of the most important royalties it owns now. The company’s always looking for, and is being offered, many opportunities across the sector. Royal Gold has very good operational experience in the industry and a great track record of identifying and investing in very high-quality assets, and then benefiting from the remarkable organic growth of many of these assets.
TGR: When a property is first optioned, some sort of net smelter-return royalty is part of the transaction most of the time. And a company ends up buying these from another that owns the actual property, correct?
IC: Yes, that’s one of the ways. Royalty companies acquire these in many different ways. They also buy them from third parties, individuals or families. For example, say your company owns a property, and another company buys it. Your company retains a 1% royalty. Then, Royal Gold can buy that royalty interest from your company. It’s also being done by companies that need financing and can come to Royal Gold and say, “I’ll give you 2% of the future production of this project if you give me this much cash up front.” The future producer secures capital to develop its project and Royal Gold retains an interest in the future production of a project. Or, it may buy it from another mining company that has a royalty (as was the case when it acquired the Barrick portfolio). There are a lot of royalties floating around and new ones being structured, and Royal Gold has been pretty successful at getting access to and acquiring these royalties.
TGR: So, you’re optimistic about the prospects for Royal Gold in the coming years, I presume?
IC: I am. I built a very complex model of Royal Gold with nearly 200 royalties, including about 35 producing and 25 in development. It’s not easy to keep track of all that and come up with a valuation; I think a lot of it gets lost by the market in that process, unfortunately. But, I do think there’s a lot of value there. This stock is trading just about $53.27 or so, but I have a target price of $81.50. I think there’s a lot of upside there that is not being priced in by the market yet.
TGR: What’s going to change between now and when you hit this target price of $81.50? What’s going to drive it?
IC: The company has all these assets and many of the important ones haven’t reached production or have just recently reached production. But the cash flow is coming. And, the great thing about a company like Royal Gold is that most of that cash is going to be free cash. Examples include projects coming on line, like the ramp up in Peñasquito, the recovery at Voisey’s Bay, the new Pascua-Lama and Mt. Milligan. Andacollo, a mine in Chile that Teck Resources Ltd. (NYSE:TCK; TSX:TCK.A, TSX:TCK.B) operates, just came online. The company is very good at picking projects and all of these are going to contribute.
In the next few quarters, as the company proves that revenues are increasing and free cash flow is going to be increasing, pushing dividends up, the market’s going to realize that these royalties are actually coming through. It’s going to take getting the message out there and companies getting more familiar with the concept. But the proof is going to be the cash-flow generation.
TGR: About how many companies are in a royalty business versus mining business?
IC: You know, there aren’t many. Now that Royal Gold has acquired IRC, the only other somewhat similar royalty company out there is Franco-Nevada Corp. (TSX:FNV), which I do not cover. Those interested in a similar business model would probably also want to look at Silver Wheaton Corp. (TSX:SLW; NYSE:SLW), a silver streaming company that operates under a similar model.
TGR: The other area you said you’re interested in is companies that are under-covered by other analysts. Could you describe or mention some of these that you think some of our readers would be interested in?
IC: I also cover Fresnillo PLC (LSE:FRES) and Compania de Minas Buenaventura (NYSE: BVN; BVL:BUE), two large mining companies, but also fairly under-covered. I cover Taseko Mines Ltd. (TSX:TKO, NYSE.A:TGB), NovaGold Resources Inc. (TSX:NG; NYSE.A:NG), Great Basin Gold Ltd. (TSX:GBG, NYSE.A:GBG) and Extorre Gold Mines Ltd. (TSX:XG; NYSE.A:XG; Fkft:E1R; OTCQX:EXGMF)—all very interesting companies worth looking at.
I have also been paying attention to companies that fit within a potential turnaround theme. At present, I probably only cover one or two companies that fit that theme; however, I think it can present great opportunities. In general, I’m referring to companies that have had their stock price depressed because of permitting roadblocks that I feel will eventually be resolved. It’s a riskier bet, clearly, and one for those investors willing to be patient and hold onto the stock, as these issues can take a while to get resolved.
Taseko is one company which, in my opinion, could become a perfect turnaround situation. I think it’s perfect because the company is already a producer. The way I see it, if you buy Taseko, you’re paying for the producing and expanding Gibraltar Mine and you’re basically getting the large Prosperity gold project, which is facing permitting difficulties, for free. That makes the risk minimal.
Another company I have been learning more about recently, but do not cover, is Revett Minerals Inc. (TSX:RVM;OTCBB:RVMIF). Its Rock Creek project is stalled due to permitting problems. But it does have a producing asset, the Troy Mine. Actually, Royal Gold owns a small royalty on that mine. Again, I think it’s a lower risk situation when it comes to this turnaround theme. There are other companies that don’t have producing assets, such as Gabriel Resources Ltd. (TSX:GBU) and Greystar Resources Ltd. (TSX:GSL), which are a bit more risky plays in that sense, but that I believe also have a very good chance of overcoming their permitting obstacles and present very good opportunities for investors.
I remember when I first started looking at this theme. It started three years ago with Eldorado Gold Corp. (TSX:ELD; NYSE:EGO). Its Kisladag mine in Turkey had been closed because of issues with the government and permitting so its stock had plummeted. I looked at the situation and understood that once the mine reopened, the stock would bounce back to where it had been or higher, which it did. Since then I’ve been keeping an eye out for others.
TGR: What other factors do you consider?
IC: Obviously you can’t just look at isolated events. You look at jurisdictions. You look at the quality of the project. You look at the strategy of the management to try to recover from whatever obstacle they’re facing. And you decide if there’s a good chance that it might indeed get resolved. I think they present a great opportunity to realize great returns with the obvious understanding that they’re riskier plays. If a project should get built, it will get built. It may just take time.
TGR: You mentioned NovaGold. Can you give us a little further explanation of what you’re thinking is on that situation?
IC: Yes, NovaGold is a very interesting company. It has a 50% stake in two main projects, the Donlin Creek project in Alaska and the Galore Creek project in British Columbia. These projects are in an early stage of development and we estimate first production will not come until 2017. Despite this, NovaGold is one of those companies you can’t afford not to consider.
You have to pay attention to it because of the size of the assets and also because of the strong partnerships. Barrick is the partner at Donlin. Teck is the partner at Galore. Both are multi-million ounce deposits, which are rare. The company also has another project, Ambler, that’s less advanced. But, it’s looking very promising and could unlock a lot of additional value for the company. So, that’s another positive.
My analysis suggests a target price of more than $18. The stock is trading at around $13.25, so we think there’s considerable upside there. The management is solid. The company’s gone through some difficult times. But it has, indeed, recovered and this has brought in some solid investors.
TGR: Are there any companies you’d like to mention, perhaps in the lower price range that our readers might be interested in taking a look at?
IC: Certainly. I’ll speak briefly about two other names I cover that I think are very interesting. I’ve been covering Great Basin Gold since I started covering the sector. It’s at a turning point right now, I think. The company has two assets, the Hollister Mine in Nevada and the Burnstone Mine in South Africa. Burnstone is actually its main project. It just came online this year. I actually visited the asset in February and was pleased to finally see the mill turning.
It’s a company that is hugely undervalued due to some delivery issues. The projects have been late in starting up and had a lot of issues with project financing. There was a lot of equity being issued and expensive debt transactions. I think the next few quarters are going to be critical in demonstrating that these mines are producing and that they’re going to be generating revenues. I would anticipate a re-rating of this stock following that performance in the next few quarters.
TGR: It’s currently trading around the $2.64 range. What are you expecting for that one?
IC: My target for Great Basin Gold now is $5.30. That’s more than double where it’s now trading. That’s only a 1.0 multiple to my valuation, which is much lower than the 1.5 or so multiple to valuation that many of these stocks trade at in the gold space.
TGR: Any others you care to mention?
IC: I also cover Extorre Gold Mines. It’s actually the most recent name I initiated coverage on. It’s a very interesting company that is a spinoff of Exeter Resource Corp. (TSX:XRC; NYSE.A:XRA; Fkft:EXB). Exeter thought it wasn’t getting much value for its Argentinean assets and it spun those into Extorre.
The Cerro Moro project is their flagship project. It’s actually a small project at this time, but what we see is that it has a lot of potential to grow. The company is drilling, increasing its resource and, at the same time, pushing the project forward toward a construction decision, which I think is fantastic. The exploration results suggest that there’s a lot of potential there. They already have a 43-101 resource and there are updates coming soon. We have a target price of about $6.70, so we feel there is upside there. And, they actually have a little bit of a potential turnaround project there with their Don Sixto Project, which has also been suspended. It’s one of those I also believe could turn around.
TGR: Why was the project suspended?
IC: Don Sixto is in the Mendoza Province of Argentina. A few years ago, the government decided that companies couldn’t use cyanide and other chemicals that are required for the metallurgical processing of gold and silver. More recently that province has issued permits to other companies in the area. The San Jorge copper project, which is operated by Coro Mining Corp. (TSX:COP), just received environmental approval this year. That, to me, is an indication that things could move forward, although I should note that Extorre management doesn’t really highlight this project at present
TGR: Does your target price of $6.70 include the potential of this project in Mendoza turning around or is it outside of that?
IC: It doesn’t. I do assign a nominal value to the project of about $60 million. The last resource on this project is actually about the same size as the current Cerro Morro resource in terms of gold ounces, although much lower grade, but my target price doesn’t include a discounted cash flow model of this project or any potential future resources or reserves.
TGR: Thank you for giving us a very good explanation of the areas you cover.
IC: Thank you.
Imaru Casanova joined McNicoll, Lewis & Vlak as a managing director in the research department in September 2010. Ms. Casanova covers the precious metals and mining sector for MLV. Most recently, she was an equity research analyst at Barnard Jacobs Mellet USA, the U.S.-based arm of the South African investment bank, where she expanded the coverage universe and product offering of the metals and mining research practice for BJM in the Americas. Ms. Casanova also has worked as an associate analyst for BMO Capital Markets’ gold research team, covering small-, intermediate- and large-cap gold mining companies. Prior to working as an analyst, Ms. Casanova was a production technologist, offshore well site supervisor and petroleum engineer for Shell Exploration and Production in Venezuela. Ms. Casanova earned an MS degree in mechanical engineering and a BS in mechanical engineering from Case Western Reserve University.
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By Ajay Shah, on April 7th, 2011
What is economic freedom?
An index of economic freedom should measure the extent to which rightly acquired property is protected and individuals are able to
engage in voluntary transactions. James Gwartney and Robert Lawson have proposed a definition where individuals have economic freedom when property they acquire without the use of force, fraud, or theft is protected from physical invasions by others and they are free to use, exchange, or give their property as long as their actions do not violate the identical rights of others.
Measuring economic freedom across countries and time
Well functioning countries today are grounded in the yin and yang of political and economic freedom. Liberals like Milton Friedman and James Buchanan suggested that it is important to measure economic freedom across countries and across time. The Fraser Institute, based in Canada, put this idea into practice and has been working on measuring the levels of economic freedom across more than 140 countries since 1970. The annual reports of the Economic Freedom of the World (EFW) are a valuable source of data on this crucial issue.
This database can be used to study the determinants of economic freedom, and its impact. As an example, we might like to examine the extent to which political freedom fuels economic freedom and economic freedom fuels political freedom (Milton Friedman’s `Capitalism and freedom’ hypothesis). Or, we might like to measure the extent to which an increase in economic freedom yields an acceleration in economic growth.
Many researchers have explored this dataset on such questions. Broadly speaking, the findings suggest that more economic
freedom is associated with greater wealth, lower poverty and higher growth. Greater economic freedom enhances civil and political
liberty.
How does India fare?
The Indian score went all the way down to 4.4 in 1975. From there, slow improvements have been obtained. The score had recovered to 4.9 in 1990 and rose sharply to 5.6 in 1995. However, as many observers have emphasised, India’s economic reforms has not been a big bang story. From 1995 onwards also, the economic freedom score has improved further to 6.6 in 2006.
In relative terms, India was at the bottom (58th out of 72) in 1975 and has recovered to roughly halfway in the world in 2006 (77th out of 141 countries). While this is an improvement compared with conditions in 1975, there is no reason why India should not continue to push on these issues, to get to the ranks of the top 20 countries of the world.
What about intra-India differences?
India is a continent-sized country, and there is considerable variation across various locations. Just as it is useful to compare
economic freedom across countries, it is useful to compare economic freedom across the states of India.
In the current political debate on stalled reforms, most eyes and hopes lie with the states. Intense political competition and
increasing political rewards for good governance are pushing states to explore and implement innovative economic, political and governance reforms. In this scenario, the Index provides an objective view on the positive and negative impacts of policy changes (or lack thereof) over a period of time.
Using the methodology adapted by the Fraser Institute’s Economic Freedom of the World annual reports, the Friedrich Naumann
Foundation alongwith its partners, the Cato Institute and Indicus Analytics, recently released their report on Economic Freedom of the States of India 2011. The report follows earlier work done by two of the authors.
The report, which is authored by Bibek Debroy, Laveesh Bhandari and Swaminathan S. Anklesaria Aiyar, ranks economic freedom in the 20 biggest states in India. This index is based on three parameters:
- Size of government
- Legal Structure and Security of Property Rights
- Regulation of Credit, Labour and Business
In summary, the findings are as follows:
| State |
Score 2005 |
Rank 2005 |
Score
2009 |
Rank 2009 |
| Tamil Nadu |
0.57 |
1 |
0.59 |
1 |
| Gujarat |
0.46 |
5 |
0.57 |
2 |
| Andhra Pradesh |
0.40 |
7 |
0.51 |
3 |
| Haryana |
0.47 |
4 |
0.47 |
4 |
| Himachal Pradesh |
0.48 |
3 |
0.43 |
5 |
| Madhya Pradesh |
0.49 |
2 |
0.42 |
6 |
| Rajasthan |
0.37 |
12 |
0.40 |
7 |
| Jharkhand |
0.40 |
8 |
0.38 |
8 |
| Jammu and Kashmir |
0.34 |
15 |
0.38 |
9 |
| Kerala |
0.38 |
10 |
0.36 |
10 |
| Maharashtra |
0.40 |
9 |
0.36 |
11 |
| Punjab |
0.41 |
6 |
0.35 |
12 |
| Karnataka |
0.36 |
13 |
0.34 |
13 |
| Uttar Pradesh |
0.35 |
14 |
0.34 |
14 |
| West Bengal |
0.31 |
18 |
0.33 |
15 |
| Chattisgarh |
0.33 |
16 |
0.33 |
16 |
| Orissa |
0.37 |
11 |
0.31 |
17 |
| Assam |
0.30 |
19 |
0.29 |
18 |
| Uttarakhand |
0.33 |
17 |
0.26 |
19 |
| Bihar |
0.25 |
20 |
0.23 |
20 |
The report has a separate chapter on Andhra Pradesh, the state that registered the fastest improvement in economic freedom moving up from seventh position in 2005 to third in 2009. Andhra Pradesh reduced waste and corruption and implemented innovative reforms. Three factors — buoyant agriculture, rural infrastructure and the elimination of Maoism — boosted employment and attracted in-migration from other states.
Did improvements in economic freedom go with improvements in investment?
CMIE maintains a database named `Capex’, which tracks all outstanding investments in a state. We focus on the stock of investment that they define as being `under implementation’. For each state, the percentage share in overall Indian investment is computed, in December 2005 and December 2009.
This graph juxtaposes the change in economic freedom (from the table above) against the change in the share in investment (in units of percentage points):
This does show a positive relation. There is a rank correlation of 0.42. It seems to say that states which improved economic freedom
tended to improve their share in investment.
As an example, Andhra Pradesh got an increase in the share of investment of 2.87 percentage points from 2005 to 2009, and Andhra
Pradesh was also a state where the economic freedom score went up by 0.11.
We have to, of course, be careful about ascribing causality. Perhaps high economic growth caused improvements in economic freedom (reverse causality). Perhaps some other unrelated factor caused both. But it is still quite interesting to find a relationship between two distinct data sources.
By B.P.T., on April 7th, 2011
The monthly Chain Store Sales report will be released today. This report on sales in chain stores gives a look at the health of stores that make up about 10% of all retail sales.
At 8:30 AM EDT, the U.S. government will release its weekly Jobless Claims report. The consensus is that there were 388,000 new jobless claims last week, which would would be 3,000 less than the number released last week.
At 10:30 AM EDT, the weekly Energy Information Administration Natural Gas Report will be released, giving an update on natural gas inventories in the United States.
At 3:00 PM EDT, the Consumer Credit report for February will be released. The consensus estimate is that there will be an increase of $5.0 billion in the consumer credit available from January to February, after an increase of $5.0 billion last month.
At 4:30 PM EDT, the Federal Reserve will release its Money Supply report, showing the amount of liquidity available in the U.S. economy.
Also at 4:30 PM EDT, the Federal Reserve will release its Balance Sheet report, showing the amount of liquidity the Fed has injected into the economy by adding or removing reserves.
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By Claus Vistesen, on April 6th, 2011
Events in Japan and Libya do not seem to have derailed the ongoing positive sentiment in the market, but it might just have alerted various Masters of the Universe that black holes (or was that swans?) are both invisible and unpredictable until they occur. It is precisely because of this that such events are important even if I think that hedging against so-called “tail risks” by buying specially tailored financial products is probably as effective as buying an extra swim suit in anticipation of the next tsunami.
On that note and if there ever was a clearly signalled change in the daily state of the market it is the end of the Fed’s QE2 and thus the end of unconventional monetary measures by the Fed. It would then seem to be a simple exercise of discounting information which is already incorporated into current market prices, but it is anything but. This is due to two things in particular;
- While it is certain that QE2 will end, it is considerably more uncertain whether QE itself will end and it seems as if the market is implicitly expecting a continuation in the form of QE3. But it is not clear cut. The macro picture is brightening in the US and Fed officials are getting more hawkish and what was certain a few months ago, may not be so certain today. In addition, if the perception changes into an expectation of an end to QE the path and pace of the Fed’s exit strategy is also uncertain.
- There is considerable uncertainty (and disagreement) as to the exact effect of QE in the first place and this shows itself on two fronts. One is the discussion of whether QE has been a success or not and the second is the more technical (yet equally important) question of through which channels QE can be shown to work (if at all). Krugman recently suggested the exactly the stock market effect which this post is based on.
In order to get to grips with this I thought it would be apt to center my analysis on the horse’s own mouth as it were and specifically the idea that the Fed is targeting stock prices. Obviously, if asked directly Bernanke and his colleagues would certainly point out that it is not all about stock prices but a much more complex issue of affecting rates on all maturities of the yield curve as well as to repair the the monetary policy transmission mechanism as well as the monetary multiplier.
Yet, given chairman Bernanke’s comments that the success of QE2 is linked to rising stock prices I thought it would be interesting to have a look at the macroeconomic effect of rising stock prices and thus the idea of the wealth effect. This is to say, what is the effect of rising stock prices on personal consumption expenditures and thus, in some sense, growth?
In summary, my analysis gives the following hints to the wealth effect in the US:
- The wealth effect from the stock market in the US is time variant but appear to be particularly strong in the period 1999 to 2010 which, in some sense, validates the Fed’s focus on stock prices.
- The wealth effect also shows up in a negative relationship between changes in the SP500 and changes in the saving rate which suggest that rising asset prices may counteract deleveraging.
- The fiscal multiplier estimated here is also time variant and seems to change signs across periods.
- The marginal propensity to consume seems to have risen over time in the US.
Here, the two last bullet points are secondary to the main focus of this note but still worth thinking about.
(click on pictures for better viewing)*
At a first glance, it is difficult to see any meaningful correlation between the two, but look closer at the period from 2007 and onwards (as well as in 2001) and you will see a closer semblance. But this may also be a case of the infamous spurious correlation as stock prices and consumption are strongly correlated around recessions and thus also in the rebound.
Surely, the linear fit depicted above for the full period is not statistically significant which suggests that measured over the grand sweep of time there is no meaningful correlation between changes in stock prices and changes in consumption expenditures. Importantly, this would also seem to invalidate the Fed’s link between QE2 and rising stock prices since such a link is empirically dubious at best. Yet, as the graph from the period 1999 to 2010 shows the link may have strengthened.
To that end I have conducted a small study fitting a linear model with the annual change in consumption expenditures as dependent variable to the change in the SP500 as well as government transfers and real disposable income to control for the marginal propensity to consume and the fiscal multiplier. I use monthly values to get 612 observations in the full sample regression (1960 -2010). Crucially, I split up the dataset in three periods; 1960-1980, 1981-1998, and 1999-2010.
In the full period, the estimation gives an MPC of 0.41 [1], a multiplier from government transfer worth of 0.09 and from the SP500 equal to 0.027 (all significant at 1%). This implies that a 1% annual return in the SP500 yields an increase the annual change of consumption expenditures of 0.027%, but the results also indicate that the “fiscal multiplier” is about three times larger. So, not exactly convincing results to support QE as an attempt to boost consumption through the stock wealth effect.
Splitting the period as noted above [2] does seem to add value to the analysis. For the period 1960-1980 the simple OLS estimate yields nothing and not even the estimate for the MPC is significant [3]. In the period from 1981 to 1998 the MPC is estimated to be 0.48, the multiplier from government transfers at 0.14 and lastly for the SP500 at 0.014 although this estimate is only significant at 10%. The period from 1981 to 1998 thus return a strong fiscal multiplier (at least in terms of significance) while a weak, at best, multiplier from the SP500.
In the final period however, something interesting happens. The MPC increases to 0.58 which squares well with the declining saving rate in the same period. More interestlingly however, the estimate for the fiscal multiplier changes signs while remaining significant at 1%. The estimate suggests that a 1% increase in government transfers will yield a -0.36% decrease in consumption expenditures. Surely, proponents of Ricardian Equivalence would be interested in testing more thoroughly for the validity of this estimate. Meanwhile, the estimate for the wealth effect from stocks is estimated at 0.035 and significant at 1% (and thus quite close to the wealth effect estimated in the full period).
Finally, and focusing on the period 1999-2010, I also fitted a linear model with the savings rate as dependent variable. The rationale here would be that the wealth effect from the stock market should materialise in a negative relationship and thus that a rising stock market would counteract deleveraging. Not surprisingly the coefficients for both changes in income and changes in government transfer are positive which suggests that higher income and transfers from the government leads to higher savings (that Ricardian Equivalence again?). The coefficient estimated for the SP500 is negative and much higher than the wealth effect to consumption. All estimates are significant at 1%.
The What, Why and Where of QE
As my readers would no doubt remind I have added nothing to the debate of whether QE affects stock prices in the first place and then has an effect on the real economy through the wealth effect. I have taken this as given on particular notice of Bernanke’s explicit comments on the success of QE2 in relation to a rising stock market.
As it turns out, the story is a bit more complicated than that.
Take Morgan Stanley’s Gerald Minack for example who recently came out strongly against the notion of QE as a driver of risky assets which invariably leads to a much more bullish and broad based recovery discourse;
I am pushing back against the view that QE – particularly the large-scale asset purchases – directly drives risk assets. The reason I am skeptical is that no one has to my satisfaction explained how – sentiment aside – QE has had a material effect on the demand for, or funding of, risk assets. It’s not even straightforward to isolate the effect of QE on the assets that the Fed purchased.
(…)
As I see it, QE2 was a $600bn placebo. If enough investors think it was good for risk assets, then perhaps it was good for risk assets. Stopping the placebo may have an effect, but my sense is the macro will remain the key driver of risk assets.
The first part of Minack’s objection to the QE-Risk Asset synthesis is important and I have also found it difficult to replicate the idea that QE directly drives risky assets . But the link need not be that specific for the end of QE to have an adverse effect of the growth narrative. I think the underlying reason as to why the market may now be driven by the improving macro picture is exactly because QE is seen as an integral part of that improvement. It then stands to reason that if and when QE ends (without extension) it will have an impact. Another point relates to the idea that the commitment itself to QE is paramount and thus that the largest effect of QE is back loaded around the announcement [4]. I think it is an accurate way to frame the effect of QE but this also implies that a second layer of expectations may take hold in the form of the expectation of the announcement. In reality, it is difficult to see how many of these “announcements” the market has discounted I think.
An altogether more heavy analysis recently came from CSLA’s Russel Napier simply noting that investors ought to sell US equities on the failure of QE2. Napier particularly makes the point that QE2 has materially failed to induce banks to increase credit.
Broad money has contracted since the launch of QEII in November 2010 and this suggests that rising growth and inflation are not likely. QEII is boosting unused bank reserves, but banks continue to shrink credit and it is having no direct positive economic impact beyond depressing Treasury yields. Equity-market valuations are close to bubble levels and need the prospect of higher inflation and negative real rates to continue higher: but M3 is contracting.
(…)
The failure of QEII will undermine investor faith in a monetary solution. With equities near bubble valuations, based on cyclically adjusted PE, a failure to reflate risks major downside. The Fed will try again with a new package, but investors would do best by waiting to see how it plays out.
This analysis then suggests a much more imminent and substantial effect of the alleged failure of QE2 and thus also the effect of a non-committal to QE3. Clearly, we are now in the situation where this illusive concept of the monetary transmission mechanism becomes important.
Thus, has QE2 succeeded because it has helped equity prices to rally or has it been a failure because of its inability to induce more than an increase in excess reserves?
I won’t pretent to give full answer on this (Napier’s analysis is difficult to disagree with) and I would like instead to yield the floor to John P. Hussman who recently had a very well written and balanced column on the end of QE2;
My intent is not to argue strongly that the economy cannot continue to expand as fiscal and monetary stimulus comes off, but instead to at least ask why this should be expected as a foregone conclusion. On the basis of leading indices of economic activity, we observe more indications of economic slowing worldwide than we observe growth. Moreover, strong periods of employment growth have historically been preceded by high, not low, real interest rates. This is far from a perfect relationship, but it is clear that historically, high real interest rates are far more indicative of strong demand for credit, new investment, and new employment than low real interest rates are.
I would file this under “I’d wish I said that”. The big question then remains as to what kind of momentum the economy and risky assets will retain once stimulus comes off.
To summarize, I have been critical of the Fed’s decision to tie its policies so close to the movements of the stock market and I still am. The idea to implicitly target stock prices is the ultimate form of hubris that a central banker can commit since it plays into the notion that the central bank can consistently fine tune financial markets. It can’t. However, my analysis above gives some support to the idea that QE works, and works well, through its effect on stock prices. At least, I would note that the extent to which e.g. Krugman is right the apparent change in the wealth effect over time gives some credence to Bernanke’s comments in 60 minutes even if I don’t agree with the Fed’s strategy on this point.
—
* The data used for my estimations are monthly data from the St. Louis Fed’s database.
[1] – Clearly this is below traditional Keynesian estimates but remember that we have monthly data in changes and thus likely to have stationary time series (i.e. we have detrended series!).To be rigorous one would obviously have to properly test the unit root properties of the series in question.
[2] – I am considering writing this up as a small paper trying to quantify the structural breaks in the data as well as to fit a non-linear model.
[3] – Which points to the notion developed exactly by researchers (Friedman for one) using data for that period that consumers spend out of permanent income and not current income.
[4] – I believe Goldman Sachs made a top notch study on this.
By The Energy Report, on April 6th, 2011
 House Mountain Partners Founder Chris Berry points to the rising quality of life in Asia as competition for strategic resources that could push the cost of energy to the breaking point. There won’t be a single solution, but more efficient electricity storage to power vehicles will be critical. High-capacity batteries are dependent on several metals, including lithium, which is still underappreciated by the commodity and equity markets. In this exclusive interview with The Energy Report, Chris shares some of his favorite lithium companies and why he sees dramatic upside potential in each one.
The Energy Report: You propose that development of lithium-ion batteries for electric vehicles (EVs) will drive increasing demand for lithium. But even assuming these new batteries, ultimately, have storage capacity of three, four or five times that of conventional nickel-metal hydride batteries (NiMH), they still have to be charged with power that comes from a source like coal, hydro, solar, wind, nuclear or whatever. My question is how do EVs alleviate the drain on resources? What’s the benefit?
Chris Berry: You know that’s a great question because it’s one that a lot of people struggle with, me included. People say that with electric vehicles you’re just trading dependence on oil for a dependence on coal or other dirty fuels to power your car. I don’t see one form of energy winning over all others.
I think coal and nuclear will probably lead the way in powering electric vehicles and providing electricity in the coming decades. But there’s definitely going to be a role for renewables, such as solar, to play in places like Phoenix, Arizona and hydropower in the northwestern United States, for example. One thing to remember is that, as the rise of the middle class in Asia continues, there certainly will be increased auto demand coming out of these countries, which means increased fossil fuel demand. This gets us back to your question, the net benefit of using EVs is resource sustainability and finding the right balance of baseload power sources. You can charge a battery from many different power sources; and, as battery technology continues to advance, so too will the power sources. But there likely won’t be a singular winner.
TER: Does your investment theory assume that higher oil prices will spur development of lithium-ion (Li-Ion) battery technology?
CB: I think that’s one of the keys but I’m not sure what the tipping point is; for instance, I don’t know if it’s $150 or $200/barrel. Higher oil prices are already filtering down to higher gasoline prices at the pump. As gas prices continue to rise, people start getting a little antsy and that filters up to politicians who can spur research and development (R&D) through increased funding on the Federal level. I just hope it’s not a matter of too little too late, as development of Li-Ion battery technology is a global competition involving multiple countries throughout the world.
TER: What’s being done now to advance lithium-ion battery technology?
CB: There’s a global competition unfolding right now to own the next-generation battery technology. Four countries are the real players here. South Korea and Japan are producing Li-Ion batteries currently, while the United States and China are playing catch-up. The competition is focused on finding a battery chemistry around which you can build an entire industry. If you own the intellectual property, you can own the supply chain, which creates manufacturing jobs—something we’ve lost in this country over the past decades.
Currently, China is investing more in battery technology than any country—to the tune of hundreds of millions of dollars—even more if you consider its entire cleantech spending budget. In 2010, China invested $34 billion in cleantech research of which battery technology is a part. In the mid-1980s, the country created what it called the “863 Program,” which still exists today under the Five-Year Plans it uses as a guide for economic policy. The 12th Five-Year Plan, by the way, which was just released is thought to be the “greenest” in China’s history. That could say something about Chinese leadership’s priorities. The 863 Program has a mandate to develop high-tech and cleantech industries; so, if you want to know what China is spending R&D dollars on and where it is focusing, looking at this data is a good start.
In the U.S., President Obama helped spur development of lithium-ion battery technology with the American Reinvestment and Recovery Act of 2009. To establish a battery-manufacturing base, $2.4 billion in grants was earmarked. The Argonne National Laboratory is also at the forefront of the research to find that next-generation breakthrough. Billions of dollars in grants have also gone to the private sector in the U.S. I’ve called this a ‘Manhattan Project’ or ‘Cold War’ because, really, we are trying to outspend and out-innovate foreign competitors to own this intellectual property. That’s the name of the game going forward.
TER: As an investor, do you have a preferred type of lithium ore? Hard rock, brine or clay? Which is best?
CB: I’m not sure if one is better than the others; I think each deposit has its own pluses and minuses. Typically, brines are the cheapest from a cost-per-ton standpoint but it can take up to 18 months to produce the lithium. On the other hand, hard rock producers can adjust to a spike in lithium demand more quickly because they can increase the rate at which they mine the ore. But they have a higher—arguably the highest—production cost among any of these ore sources. Clay is right in the middle.
TER: Which lithium producers do you prefer?
CB: The four major lithium producers are working with the highest grade of known resources currently. On the hard rock side, Talison Lithium Ltd. (TSX:TLH) has its Greenbushes operation near Perth, Australia. It has 3.5%–4.5% lithium oxide, which is extremely high for hard rock deposits and is, in fact, the highest-grade lithium produced in the world today. That gives the company a distinct production economics advantage. Talison is an interesting story because it’s the only pure-play lithium producer listed on an exchange globally. It came public through a reverse takeover of a small junior called Salares Lithium in Chile. As I mentioned, Talison is producing the highest-grade lithium in the world and because of that, it is supplying 75% of China’s lithium needs—nobody else comes close.
On the brine side, the same can be said with Sociedad Quimica y Minera de Chile SA (NYSE:SQM; SN:SQM) in Chile. It produces lithium from the Salar de Atacama, an extremely high-grade brine lake. I know it can be controversial, but I prefer hard rock production due to the ability to scale to both size and demand more quickly.
TER: Talison’s market cap is just under $500 million. That really sounds low considering it’s the only public pure-play lithium company. From what I understand, it supplies one-third of the world’s current lithium market. So what am I missing here, Chris?
CB: It’s still a new story, relatively unknown. It has been public only for five or six months now, and I think the market may not understand the pure-play aspect of this company, which is extremely powerful. The other three major lithium producers globally are SQM, FMC Lithium Corporation (NYSE:FMC) and a specialty company Chemetall (Pty) Ltd., which is a division of Rockwood Holdings, Inc. (NYSE:ROC). All three of these companies trade on the New York Stock Exchange between roughly $50 and $80 per share but are known for the specialty chemical aspects of their businesses. SQM is a great example. It is a huge potash producer with lithium produced as a byproduct. Lithium accounts for just 8% of SQM’s total yearly revenue and yet the company’s one of the largest lithium producers in the world, even though the company views it as a byproduct.
So, the point with Talison is that it’s the only one that owns this pure-play production space, has the highest-grade lithium in the world and is still in its public company infancy. As Talison continues to increase capacity and supply high-grade lithium to China (predominately), more and more people are going to find out about this. There’s also additional exploration upside at the Salares 7 brines in Chile that it acquired in the reverse takeover of Salares Lithium. I think the stock is really undervalued given the stranglehold Talison has on the lithium space.
TER: Does Talison own its entire supply chain?
CB: Not currently. The company supplies two types of concentrates—one is a technical grade and the other a chemical grade. The technical grade is used in glass and ceramics, which account for 30% of global lithium demand. The chemical grade is what TLH sends to China for conversion into lithium carbonate for batteries. Talison has begun a scoping study to evaluate the possibility of building its own lithium carbonate plant.
TER: How much can Talison increase margins by owning a lithium carbonate processing plant?
CB: It’s hard to say without knowing the capital costs. If the company can build and operate the plant with expenses of less than $2,800/ton to produce lithium carbonate (which sells on the open market for around $5,000/ton now), it could see some really healthy margins.
TER: So, at this point, Talison is more of a growth story than a value story?
CB: I think it’s a growth story, but there is unrealized value here. The fact that Talison’s customers are dependent on it for the quality of lithium the company produces, and also that Talison is not only selling 100% of what it produces but working to double production capacity, should only cement its place as a globally dominant lithium producer.
TER: I note that TLH has pulled back by almost one-third over the past three months. Was there any particular tipping point, or was this a technical issue? (Others also pulled back during that time.)
CB: With respect to Talison, I think it’s likely a technical issue. The lithium space, in general, has had a few hiccups lately. Some interesting companies are still out there, however. One example is Western Lithium USA Corp. (TSX:WLC; OTCQX:WLCDF), a lithium clay explorer based in Nevada. It has a very large resource called Kings Valley in Nevada where it has produced battery-grade lithium in pilot tests as recently as late last year. That provides a high degree of confidence regarding any metallurgy issues.
The company is working on a prefeasibility study (PFS) this year and continuing to drill and increase the size of the resource. The good thing about lithium is that, unlike rare earths, the United States is not 100% dependent on lithium imports. There’s plenty of lithium out there in stable geopolitical locales and Western Lithium’s Nevada deposit is an example.
The questions are: What’s the cost of production? What’s the grade? Western Lithium has said it will be able to produce at just under $2,000/ton, which is slightly more expensive than the brines but a heck of a lot cheaper than the hard rock guys. This company is planning to be in production by 2014. It’s doing all the right things to position itself to achieve this; so, Western Lithium has a great chance.
Another interesting early stage play is Rock Tech Lithium, Inc. (TSX.V:RCK; OTCPK:RCKTF; Fkft:RJIA), which is focused on hard rock lithium and rare metal deposits in Canada. The company has a historical resource that it’s working to bring into NI 43-101 compliance by this summer. The location of the deposits and a wealth of historic drill data are two reasons this stock interests me. The whole lithium space has been under pressure recently as have many lithium juniors, but I think it’s been a market overreaction more than anything specific.
One possible cause of the recent depressed stock prices could be that Galaxy Resources Ltd. (ASX:GXY) was planning on doing a $250M IPO in Hong Kong to increase its footprint in the lithium space but delayed it due to market conditions. I think that may have hurt the price of many of the lithium juniors more than any other reason.
TER: Do you expect Galaxy to proceed with its IPO this year?
CB: My understanding is that the company shelved it because market conditions weren’t optimal. If things change, it may, but that’s really a question that company management would be better suited to answer. I know Galaxy recently achieved production out of its Ravensthorpe deposit in Western Australia, which is a positive sign; so, perhaps the IPO can wait, as the company is now generating cash from the sale of its product. Galaxy also has done a joint venture (JV) with Lithium One Inc. (TSX.V:LI), which is another interesting company in that it has attracted the attention of not only a lithium producer (Galaxy), but also Korea Resource Corporation (KORES), GS Caltex Corp. and LG Chem Ltd. (KSE:051910; KSE:051915; OTC:LGCEY)—one of the largest battery manufacturers in the world.
TER: Considering the mindset of North American investors, is there something they’re not seeing here? Because we’re going to drive big vehicles, so perhaps we don’t see the potential in these EVs?
CB: That raises a good point. I think there are certain psychological drawbacks to electric vehicles in this country today, and one of those is “range anxiety.” It’s the underlying question, ‘If I get a Nissan Leaf and the battery dies after 75 miles, what do I do?’ ‘What do I do if I have to drive 300 miles?’ That’s why I think plug-in hybrids—those that have a small gas tank and an electric battery—are going to be more popular in the U.S., at least initially. I’m not sure if the size of the vehicle is as important an issue as finding the right battery chemistry that discharges more slowly and recharges more quickly than do current EV batteries.
TER: What about the concept of battery exchanges along the way where you might drive 75–100 miles and exchange that battery for a charged one?
CB: Absolutely. An Israeli company called Better Place is attempting to address this issue. What you mentioned in your question is essentially Founder Shai Agassi’s business model. You drive and when the battery gets close to running out, you go to a depot and exchange it for a new one. Additionally, the company is working to set up a charging infrastructure and make its battery-switching technology and charging stations standard across different vehicle models.
You also raised an interesting point about infrastructure and battery-charging infrastructure in this country. I think this whole EV phenomenon is going to take place much faster in Asia, where the company’s building its infrastructure from the ground up. In the U.S., there’s a chicken and the egg problem. I’m generalizing here, but nobody wants to buy an electric car until they know there are ample charging stations and better battery chemistry in place. But governments and private industries aren’t likely to spend, time, money and other resources building charging stations until they’re confident there’s enough EV demand out there. Ultimately, this is a multidecade phenomenon. Infrastructure buildouts are happening in places like Israel and Asia but, going forward, the real winners in this industry will own the entire electric vehicle supply chain—from raw material sourcing to battery manufacture to charging infrastructure. The race is on.
TER: Chris, I’ve enjoyed meeting you very much. This has been a tremendous pleasure for me.
CB: Me, too. Thank you.
With a lifelong interest in geopolitics and the financial issues that emerge from these relationships, Chris Berry founded House Mountain Partners in 2010. House Mountain firmly believes that the emerging quality-of-life cycle emanating from Asia is a “game-changer” that will affect everyone throughout the world for decades. With that in mind, the firm focuses on the intersection of three topics: 1) The evolving geopolitical relationship between emerging and developed economies; 2) The commodity space; and 3) Junior mining and resource stocks are positioned to benefit from this phenomenon. Chris spent 13 years working across various roles in sales and brokerage on Wall Street before founding House Mountain Partners. He holds an MBA in finance with an international focus from Fordham University and a BA in international studies from the Virginia Military Institute. Chris is also a member of the Canadian American Business Council. He invites readers to receive a complimentary subscription to Morning Notes, which provides analyses of emerging geopolitical, technological and economic trends. Go to www.discoveryinvesting.com.
By Ajay Shah, on April 6th, 2011
As Vijay Kelkar has long emphasised, India’s privatisation question should be viewed as a question about the portfolio of the State. For each Rs.10,000 crore of shares of Air India that the government owns, it is forgoing 2,000 kilometres of highways. The State needs to ask itself whether it is better to own 2,000 kilometres of highways as opposed to owning the same shares of Air India. On this subject, also see Section 4.3 of this paper.
The second key dimension that should shape the discussion on privatisation is that of improving GDP growth. When assets are moved from public control to private control, the translation of capital stock and labour into GDP growth generally becomes more effective. Through this, India would reap GDP growth by better utilisation of existing resources.
Both these issues have, so far, been largely seen questions about the control of public sector undertakings (PSUs). But both issues are broader: they are about asset ownership by the government more broadly. Given India’s socialist background, government has frequently and wantonly grabbed assets, far beyond those required for the production of public goods. Hence, the problem of selling off assets is much bigger than just PSUs.
As an example, this article says:
The defence ministry is the largest state landowner, holding 80 percent of the 7,000 square kilometres of government land, much of it now prime real estate, according to the CAG report released Friday.
Here is the CAG report referenced there.
There are two interesting dimensions to the problems of defence land. First, while the Ministry of Defence undoubtedly needs large tracts of land on which it can run exercises, training, experiments, etc., it certainly does not require prime land in cities. There may be a role for one big HQ in New Delhi, but I don’t see why the DRDO or dozens or other defence installations are required to be in Delhi. The governments stands to raise trillions of rupees by selling this land and shifting these organisations to locations in the boondocks, where land is roughly free. And there is a further kicker: When defence holdings in places like New Delhi or Poona are moved off into private ownership, India’s GDP will go up. So this is a win-win at two levels: First, India’s fiscal problem is eased by selling defence land and writing down debt, and India’s GDP is increased because the land gets put to productive use.
Similarly, I don’t see why anything connected with the Indian Navy needs to be in Bombay. It’s perfectly feasible to create naval bases at boondocks locations on the coast and thus free up the space used in high marginal product land.
The second interesting dimension is that of the Ministry of Defence as a creator of new cities. If you start off with land in the boondocks, on day one, nobody wants to go there. The Ministry of Defence has the ability to solve the coordination problem. It can engineer the synchronised movement of a large number of distinct pieces that are required to create a new cantonment town. Once this has been put into motion, within 20 years or so after starting up, it would be wise for the government to sell this off and start over. For MoD, there is little difference between being in a mature cantonment town versus a brand-new one. But for the exchequer, enormous value is created through this process. And for India, this works well because new cities can be steadily created in this fashion.
By B.P.T., on April 6th, 2011
The Mortgage Bankers’ Association purchase index was released at 7:00 AM EDT, and there was a week to week increase of 6.7% in the Purchase Index and a week to week decrease of 6.2% in the Refinance Index.
At 10:30 AM EDT, the weekly Energy Information Administration Petroleum Status Report will be released, giving investors an update on oil inventories in the United States.
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By Simon Grey, on April 5th, 2011
This approach provides a way to see the problems government has in allocating resources even remotely well: It’s not just that government gets it wrong at various points but that political processes do not have the same error detection and correction abilities that markets have. Political actors are far less likely to know when they’ve erred and to have the right incentives to correct things. Government is not only less able to get it right; it’s also less able to know when it’s got it wrong.
A whole new light is now shed on the idea of “market failure.” In this more Austrian view, markets frequently “fail” by not allocating resources optimally at a given time. But calling this a “failure” ignores the Austrian point that what markets are particularly good at is telling us that resources are not optimally allocated and providing the knowledge and incentives necessary to correct the errors. From the Austrian perspective, “failure” should refer not to suboptimal allocation at a given time, but rather the inability to detect and correct error. If we understand that the crucial question is how well alternative processes do those things, we realize that supposed market “failures” are better seen as opportunities for market successes.
“Market failure” occurs quite often in the free market because costless, infinite, perfect information does not exist. As such, there will always be times when resources are not allocated as efficiently as possible. What statists fail to realize is that the same holds true for state-governed markets. Switching from a demand to a command economy doesn’t magically cause costless, infinite, perfect information to appear. Rather, what happens is that those in charge of a command economy take on the pretense of knowledge.
Another flaw in analyzing “market failure” is analysis makes use of static models even though the market is a dynamic entity. This usually leads to calls for intervention at the slightest sign of trouble, even though the market has repeatedly proven to be self-correcting. A simple glance at any growth chart, whether of nations or businesses, or any other market entity, will show that growth is not perfectly linear. Sometimes, say, a business will experience market growth; other time it will experience losses. Some strategies will work spectacularly; others will flop like a dead fish. Trying to pronounce judgment on a given system in response to just one small sliver of data is foolish, to say the least.
A better method of analysis is to compare a system’s historic performance in relations to its purpose/ability. No one claims that the free market serves as a system of social justice, nor does anyone claim that it operates smoothly and flawlessly. Really, the only claim that anyone can make is that the free market is the most efficient of allocating scarce resources to those who desire them the most. Historically, the free market has done a very good job of accomplishing this goal, particularly in comparison to the alternatives. America’s market slowdown in recent years is due to the government’s attempt at imposing a soft statism over the economy.
Does the free market fail occasionally? Most certainly. But is that failure permanent or uncorrectable? Most certainly not. More importantly, the free market, even with all it imperfections, is still the best method of allocating scarce resources.
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