In college, probably our crowd’s favorite two indoor games were Risk (the game of world domination, in retrospect a funny fave for a group of aggressively anti-war counter-cultural types) and Indian Poker. We all know about risk on and risk off in the financial markets, but Indian Poker has its place.
For those unfamiliar with the term, Indian Poker is played by placing a single playing card on one’s forehead facing outward, visible to the other player or players.
Betting then ensues, with high card winning. The suit is irrelevant.
The game is also known in polite company as blind man’s bluff. In college, among the more printable names by which we knew it were Bullsh-t and One-Card Schm-ck. Gambling is done with faux or real money.
Here’s how one game might evolve, with follow-up reference to financial markets.
Let’s say for simplicity that you are in a two-person game, which was our favorite way to play. Mano a mano or, more properly, forehead a forehead.
Let’s say you pick a 2. With aces high, you’re in trouble. Your opponent knows he can’t lose. 48 times out of 51, he’s got you beat;
3/51 times he will also have a 2 and the round will be a draw. It’s in his interest to make you think you have an ace rather than a pitiful deuce. He thus may play possum to get you to bid him up to a high level. Then he closes the trap.
When you see your card, you realize he’s been slinging the sh-t and that you were the schm-ck. Thus our terms for the game.
As in Indian Poker, so in financial markets. The insiders don’t necessarily hold all the cards, but they see them more comprehensively and earlier than you.
One of the examples of this came in the second half of the 1990s. The insiders knew that most of the tech stocks were overpriced, and the fact that the media and financial community induced a mania by pushing prices illogically higher was just like your opponent letting you push the stakes higher and higher when in fact your deuce had no chance of winning. The housing scam of the aughties was similar. In each case, large amounts of money were made by the connected class on the way up and also on the way down.
Nowadays, I think that there is also a scam going on. The scam is called fighting deflation. The authorities are playing the game of Bullsh-t with the public. They are trying to convince them of the opposite of what is really happening, on plan and on schedule, which is worsening inflation.
MIT’s Billion Prices Project is showing a 3% year-on-year rate of price increases from its survey of online retailers. Since this survey covers neither houses (stable to downward pricing) nor oil products nor food (soaring pricing), let’s say that the true CPI is in fact 3%. Thus pricing short-term interest rates near zero is wildly inappropriate.
Eddy Elfenbein of CrossingWallStreet.com has calculated that a short-term interest rate Fed strategy that produces stable gold prices is one in which the 3-month T-bill rate is 2 points above CPI. For every point above or below that metric, the price of gold moves down or up 8% over the next year. Thus if CPI and interest rates were both 3%, the correlation he has discovered would project that gold prices would rise at a 16% annual rate. Right now the Fed is behind the Elfenbein curve by about 5 points. This would project a 40% price increase for gold this year should conditions stay as is. That would translate to about a $2000 gold price within a year. (There is of course no guarantee that this a posteriori relationship will continue to hold.)
We are seeing a form of a rerun of the inflationary booms or boomlets of the late 1960s and 1970s. The authorities are blasé. I am not.
What happens in the Mideast is of little importance to the general price level. If oil is more plentiful, then pricing power will move to other sectors, but Austrian economic theory states that the net effect is the same. The central bank is creating a great deal of base money at vastly inflated price (overly low yield, in other words). The Federal government is using its command and control structure to force-feed the economy to grow. Of course, much of this Federally-induced spending is malinvestment and is wasted from the standpoint of providing the capital needed for legitimate future growth. Thus a true, durable boom appears unlikely.
One way to be the winner in the game of One-Card Schm-ck that Dr. Bernanke and the Feds are playing with the public is to watch what they do, not what they say. The Treasury is selling overpriced securities to its captive central bank, with the Primary Dealers acting as middlemen to keep the form of the circular debt monetization proper.
It is true that as in 2008, the system can crash and there can be a brief period of true deflation. I see that as a low probability event for the months ahead. To base one’s investing on the possibility or even probability of another 2008 is indeed a rational strategy, but one that requires the patience to lose ground steadily to the money-printing in the hope of jumping in during a panic.
In this particular case, you can avoid being the schm-ck by seeing that the Feds are holding deuces. You probably don’t want to buy their patter or their inventory. Eventually, there will come a time when they will be forced to truly “fight inflation” and when the gold bugs will be pushing overpriced merchandise. I can’t wait for that future game of Indian Poker, but I’m not holding my breath for it to begin any time soon.
Copyright (C) Long Lake LLC 2011.
Thanks for writing this, DoctoRx. I love the analogy to Indian Poker. Too many people “invest”, trade, and/or speculate without having the slightest grasp of anything. They get what they deserve, which is a big loss.
However, I don’t agree with how you use “inflation” (as an increase of prices, Billion Prices, CPI, or the Keith Index). To focus on prices (and how much higher than the rate of price rising the interest rate ought to be (according to some econometric model) misses all of the big points of Austrian (i.e. real) economics:
– people have reason and volition, you cannot model them the way you would particles in an ideal gas
– correlation is not causality
– there is no particular quantity of money or absolute price level that destabilizes the game…
– …but there is a particular amount of debt that does: when the interest cannot be paid
– while I agree we won’t necessarily have a repeat of 2008 this year, it is certain that we will have another 1000X worse (the dollar goes to zero)
– which means gold will not be “overpriced”; gold is money and all irredeemable paper currencies die
– it also means that the Fed *IS* trying to fight something (the wrong way, and it isn’t possible to fight anyways). Debt has already accumulated way past any possible hope of repayment. On top of this, everyone is borrowing short to lend long. The former means defaults are inevitable, the latter means each default will have a non-linear and possibly catastrophic impact on all sorts of things, not just the creditors
– the problems with artificially low interest rates are:
. it hurts those on fixed income
. it discourages saving
. it strongly encourages foolish risk-taking (leading to bubbles)
. it encourages malinvestment and consumption of capital
In a free market, including a free market in money (i.e. gold) and a free market in interest rates, market forces (i.e. arbitrage) sets the interest rates. The floor under rates is set by the marginal saver. At some threshold, he withdraws his gold coin from the banking system out of protest for low rates and takes it home to hoard. The ceiling is set by the marginal entrepreneur. If the interest rate goes above his rate of profit, he liquidates his business and invests the proceeds in the bonds of an enterprise. Not only does he get the benefit of a higher rate of return than in his old business, but he doesn’t have the risk and stress.
In our Central State Planning system, replete with ponzi irredeemable currency, check-kiting between the Treasury and Fed, front-running the Fed’s daily purchases of Treasurys, and other insane ideas straight out of Atlas Shrugged mashed up with 1984 and The Matrix, interest rates are dictated by the Fed on the short end, and more or less controlled by the Fed on the long end. There is no way to know what the interest rate should be, without a market to discover it. But given that our crisis is one of capital decumulation, it is a simple statement to say that interest rates should be far higher than they are now. That would attract savings to capitalize the projects that promise to create wealth and force a liquidation of malinvestment that continues to destroy wealth.
I feel that anyone who gets in stocks, bonds, or currencies is foolish based on the hard facts in this article.
I fully believe the Austrian theory of inflation etc, but one thing that bugs me is that inflation expectations are still so low.
It’s hard to reconcile an inflationary environment with wage growth being anemic, and the first signs of interest rate tightening should see the heat come out of commodities. Just a question of timing, though we could be waiting some time….
Revilo:
The Japan tragedy is doing the commodity job for now. Assuming no Chernobyl-type devastation, though, they will rebuild, and that will pressure industrial commodities up in price. I partially agree w you on wage growth, but only partially. When you exclude the increasingly forgotten long-term unemployed, there is much less of a wage and employment issue in America than the headlines suggest. Also, much of what the Fed is creating new money for is to allow gov’t to provide income to non-workers, such as Soc Security recipients, Medicaid/welfare recipients (and corporate welfare recipients), so that they compete for goods and services with workers whose after-tax wages are lagging cost of living increases. It is the competition of working people with those more favored by govt largesse that drives up prices more than wage increases should suggest. (IMHO)
Hi Doc, as usual very interesting piece.
as i have said before, i am not well-read on the subject of economics. Jeff and later Keith have taught me, by default, that i most closely subscribe to Austrian theory. i have always known that any demand-side thinking is hogwash.
the thing about this “recovery” that drives me to drink at breakfast is that the mainstream relies on GDP and the CPI as a measure, and to me, these measures are nearly meaningless when assessing the situation. money created by the Fed and dispersed by the federal gov’t as income to non-workers does not count in my book. but it does have an impact.
my point is that we now have electronic bread lines. i am not sure if inflation is always a monetary phenomenon, i’ll leave that to the experts who are regular contributors to this site.
i do know that with wages stagnant and unemployment high, prices can still increase in all the wrong places, while not increasing in the right places (though not decreasing fast enough to spur increased transaction activity). this does not appear to be a healthy situation to me.
dd: I concur. There’s little difference if wages are stagnant and prices rise 5%, or wages rise 5% and prices rise 10%.