Market Surges On Euro News, New Nobel Prize Winners, and Why China Will Bust

Like clockwork, the market rallied today on another optimistic meeting between Sarkozy and Merkel:

Angela Merkel and Nicolas Sarkozy turned their crisis-fighting focus to banks, promising a recapitalization blueprint this month that will overtake a 12- week-old rescue plan that has yet to be put into place.
“We will recapitalize the banks,” the French president said in Berlin yesterday at a joint briefing with the German chancellor without providing details. “We’ll do it in complete agreement with our German friends because the economy needs it, to assure growth and financing.”

This is becoming a running joke as Merkel and Sarkozy control world markets by whatever garbage comes spewing out of their mouth.  Like vermins, the market sniffs out the good news, gorges itself on it, and goes crazy.  Yet underlying problems like oh say the Greek 1-year bond hitting a yield of 150% :

The Central Bank of Portugal saying that budget austerity marks might not be met:

he Central Bank of Portugal warned the economy might fail to meet budget deficit targets set for this year and next under the EU/IMF programme (5.9% and 4.5% of GDP, respectively), unless it takes "significant additional measures".
According to the report, lower-than-previously projected GDP growth and lack of implementation of structural reforms (as opposed to one-off actions) would be responsible for the anticipated fiscal slippage in 2012. The Central Bank expects GDP growth to contract 1.9% this year

Or Italian Prime Minister Silvia Berlusconi blaming market volatility on cocaine aren't ever considered:

"Italian Prime Minister Silvio Berlusconi's Undersecretary Carlo Giovanardi said the government will study if it's feasible to conduct drug tests on stock-exchange traders, with the help of the Milan Bourse and the country's market regulator. Giovanardi, who is in charge of family policy and drug prevention, said that the abuse of drugs including cocaine might explain part of recent stock volatility."

With such genius at the helm, patting us on the head, and telling us everything is going to be alright, what could there be to worry about...?

And of course there are those damn insignificant Euro countries that are reluctant to keep bailing out the banks:

• SLOVAK COALITION TALKS ON EFSF END WITH NO DEAL, TO CONTINUE TUESDAY MORNING - PARTY LEADER
• SLOVAK PM RADICOVA SAYS NO DEAL ON EFSF ON MONDAY, MORE TALKS 0700 GMT ON TUESDAY

So while all signs show that nothing has been solved, the market gobbles up the crap coming out of Sarkozy's and Merkel's mouth.  And you wonder how things went wrong.
Russel Napier nails it:

Oh well, at least there is Sausage the Greece Riot Dog to entertain us:

With much of the monetary chaos going on that is the result of failed Keynesian macro-econometric modeling, it only makes sense that the two newly dubbed winners of the Nobel Prize in Economics, Thomas Sargent and Christopher Sims, made their fame in econometrics.  Via Tyler Cohen:

Let’s go back to the Lucas Critique of 1976. Lucas looked at the large econometric models of the 1970s, models that contained hundreds of variables relating economic aggregates like income, consumption, unemployment and so forth. Lucas then asked whether these models could be used to predict the impact of new policies. One could certainly take the regression coefficients from these models and forecast but Lucas argued that such a method was invalid because the regression coefficients themselves would change with new policies.
If you wanted to understand the effects of a new policy you had to go deeper, you had to model the decision rules of individuals based on deep, invariant or “structural” factors, factors such as how people value labor and leisure, that would not change as policy changed and you had to include in your macro model another deep factor, expectations.
The Nobel for Christopher Sims and Thomas Sargent is for work each did in their quite different ways to develop ideas and techniques to address the Lucas Critique. Sargent’s (1973, 1976) early work showed how models incorporating rational expectations could be tested empirically. In many of these early models, Sargent showed that including rational expectations in a model could lead to invariance results, nominal shocks caused by changes in the money supply, for example, wouldn’t matter.

Time to queue in a relevant passage from Rothbard on the fallacy of applying constants (physical science and mathematics) with human action (praxeology and social sciences), thanks to EPJ:

Not only measurement but the use of mathematics in general in the social sciences and philosophy today, is an illegitimate transfer from physics. In the first place, a mathematical equation implies the existence of quantities that can be equated, which in turn implies a unit of measurement for these quantities. Second, mathematical relations are functional; that is, variables are interdependent, and identifying the causal variable depends on which is held as given and which is changed. This methodology is appropriate in physics, where entities do not themselves provide the causes for their actions, but instead are determined by discoverable quantitative laws of their nature and the nature of the interacting entities. But in human action, the free-will choice of the human consciousness is the cause, and this cause generates certain effects. The mathematical concept of an interdetermining "function" is therefore inappropriate.

Other metaphors bodily and misleadingly transplanted from physics include: "equilibrium," "elasticity," "statics and dynamics," "velocity of circulation," and "friction." "Equilibrium" in physics is a state in which an entity remains; but in economics or politics there is never really such an equilibrium state existing; there is but a tendency in that direction. Moreover, the term equilibrium" has emotional connotations, and so it was only a brief step to the further mischief of holding up equilibrium as not only possible, but as the ideal by which to gauge all existing institutions. But since man, by his very nature, must keep acting, he cannot be in equilibrium while he lives, and therefore the ideal, being impossible, is also inappropriate.

As long as economists continue to think that mathematical modeling can predict human behavior, we will keep seeing disastrous policies like the European currency union and crony capitalist bailouts.  Since we are on the verge of another large chain of bank recapitalizations (nationalizations) in Europe, it looks like China is getting in on the party as well with their state owned banks, via Financial Times:

The Chinese government will boost its stakes in the country’s largest banks, as it attempts to shore up slumping financial stocks and to restore investor confidence.
Central Huijin, the domestic arm of China’s sovereign wealth fund, will purchase shares in Agricultural Bank of China, Bank of China, China Construction Bank and Industrial and Commercial Bank of China, the official Xinhua news agency announced on Monday. Xinhua added that the purchases by Huijin – its first such public intervention since a similar decision at the onset of the financial crisis three years ago – would “support the healthy operations and development of key state-owned financial institutions and stabilise the share prices of state-owned commercial banks”.

While the banks being propped up in China are state owned, like Don Luskin says of U.S. banks,"They should really be seen as a highly regulated public utility."  And that's how politicians are going to continue to treat them.

Kel Kelly has a brilliant article out at Mises Daily today on the incoming China property bubble collapse.  Not only does Kelly show how the collapse is coming in brilliant and detailed fashion, he does so by tackling and eviscerating many modern monetary myths.  Some highlights:

The truth is that there is no such thing as importing or exporting inflation, because each country or currency area has its own individual currency, which is separate from another region's currency. Prices within a particular currency area can rise only when that particular currency is inflated. (A rare exception is when other currencies also circulate within the same currency area, and an increase in the quantity of the other currencies causes prices to rise in that currency. But even in this case, the depreciating currency will likely soon stop circulating as it will be shunned for the stronger currency.)
But currency changes can indeed affect prices by way of changes in the supply of goods. A country whose currency is artificially undervalued — such as China — will artificially export more and import less. If the currency is allowed to rise towards the market exchange rate, it will begin to export less and import more.
All else being equal, a higher-priced currency will indeed result in a lowered price of imported goods. When imported goods cost less, consumers have more money to spend on domestic goods; purchasing power increases. Or, if the amount saved from spending less on imports is spent on acquiring greater amounts of the imported goods, there will be less demand for domestic goods, causing domestic prices to be lower. In either case, what has lowered prices is a stronger currency.

A manipulated currency can cause domestic prices to be artificially higher or lower than they would otherwise be, but it cannot cause prices to rise on a sustained basis; it cannot cause price inflation.

There is no such thing as an overheated economy. "Overheating" is the Keynesian term for price inflation arising as a result of too much monetary pumping into the economy. It is the monetary pumping that has pushed China's GDP into double-digit gains. As for sustainable growth, it is only monetary GDP growth that is unsustainable. Real, true economic growth is always sustainable and could never exceed what Keynesians call an economy's "potential long-term growth rate."

Therefore, letting its currency rise will cause a recession, since reduced money-supply and credit-growth rates are the usual initiating factors that bring on recessions (reduced rates of spending alone can cause recessions, but they are usually preceded by prior reductions in money and credit). It has been rapid increases in money and credit that have driven the current boom in China, and it will be the reduction in the growth rate of those variables that causes the bust.
The economic boom in China has consisted of rapid increases in true economic growth accompanied by — but not driven by — an increase in monetary spending. The increase in monetary spending, in turn, has been driven by wild credit growth, and has resulted in massive overinvestment in particular industries. There has been no shortage of commentaries and videos highlighting building booms, mania-type herd-mentality home buying, and the mass creation of buildings, shopping malls, and even multiple entire cities in China that stand unoccupied — all dramatic yet classic symptoms of credit bubbles.

Though Kelly's article can be a bit technical at points, he ends up clearly tackling the issue and shows that China's imploding economy can't be stopped by hiking interest rates.  The fix is in from the previous money printing and the property and construction bubble will be popping soon.  This will put downward pressure on global commodities by which Bernanke mad money printing may or may not offset. Great article Kel!