The Law of Unintended Consequences: The Worst Mistake in Decades

By JEFFREY SICA

Image by AFP/Getty Images via @daylife

 Jeff discusses the concept of unintended consequences as it relates to decisions made by the Fed.

The law of unintended consequences has long existed dating back to at least Adam Smith but was popularized in the twentieth century by sociologist Robert K. Merton. In his theory, Merton stated that often unanticipated consequences or unforeseen consequences are outcomes that are not the outcomes intended by a purposeful action. In some cases, the law of unintended consequences could create a perverse effect contrary to what was originally intended and ultimately making the problem worse.
 In the economic downturn of 2008, the central bank undertook a series of what they considered “positive initiatives” to stimulate the economy. Fed Chairman Ben Bernanke defended his position by saying that the policy of “quantitative easing” (bond purchasing), will “stimulate the economy and create jobs”.  In other words, stimulate the economy by printing massive amounts of money.
 The unintended consequence of these initiatives will prove to be catastrophic in the long term. The cause of this unanticipated consequence is something Merton called the “relevance paradox”, where decision makers think they know their areas of ignorance regarding an issue, obtain the necessary information to fill that ignorance void but intentionally neglect other areas as its relevance is not obvious to them. This is exactly the case with our central bank.

 To clarify, Ben Bernanke has intentionally ignored the short term consequenceof his QE initiative through a justification of the potential long term positive effect.  In recent testimony before capitol hill, Bernanke stated, “while indicators on spending and production have been encouraging on balance, the job market has improved only slowly” adding, “it will be several years before the job rate is back to normal”, despite some positive signs that cropped up in January. Bernanke has chosen to ignore the negative “job market” consequences by stating that it will recover in a few years and focus on the minor positive. He continues to forge ahead while ignoring the relevance of negatives such as a surge in inflation in commodities, precious metals, and most importantly oil due to the systematic devaluation (destruction of the U S dollar) as well as the world wide chaos which has been ignited by inflation and rising food prices.

 The unintended consequence of these Fed actions will result in the only economic condition worse than inflation, which is “stagflation”, in which the inflation rate is high and the economic growth rate is low. What will make this condition considerably adverse is the inverse relationship between the U S dollar and oil prices. Oil prices have historically increased as the value of the dollar decreases. Oil prices can exceed their 2008  high of $148 .00 per barrel  especially considering the fact that with oil prices at a historic high in 2008, the value of the U S dollar  was considerably higher. The unintended consequence of a “weak dollar” which is supposed to spur exports and stimulate our economy is more inflation and greater upside pressure on commodities and oil than we saw in 2008.

 Merton believed that the ultimate flaw of mankind is hubris – our belief that we could fully control the world around us and that we put our immediate interest before our long term interests. Ben Bernanke and the central bank are guilty of “hubris”, as they continue to put their immediate interests before that of the nation’s long term interest. Their actions will force us to live with “unintended consequences” for decades to come.
 To quote French novelist and Nobel Prize winner, Albert Camus, “the evil in the world almost always comes of ignorance, and good intentions may do as much harm as malevolence if they lack understanding”. In our financial lives it is imperative to invest with the foreknowledge that we may have to endure many “unintended consequences” inflicted on us by a “well intentioned” government to achieve our financial success.
 Reason is our only defense. To quote Ayn Rand, “From the smallest necessity to the highest religious abstraction, from the wheel to the skyscraper, everything we have comes from one attribute of man … the function of his reasoning mind”.

Blissful Ignorance: Why the Financial Markets are Ignoring the Crisis in Egypt



There is little acknowledgement

of the trouble that lies ahead

when relying on a philosophy

of “blissful ignorance” in regards

 to Egypt and its impact on the economy.

The phrase “ignorance is bliss” is a passage from a Thomas Gray poem “Ode on a Distant Prospect of Eton College” (1742). The complete phrase, “Where ignorance is bliss, ‘tis folly to be wise” has often been interpreted as “what you don’t know can’t hurt you”. Unfortunately, using this proverb as the approach by which the United States deals with situations in the Mideast is a dangerous and destructive philosophy.

 

The most egregious U.S. foreign policy mistake of the last 50 years was Jimmy Carter’s decision to demand the Shah of Iran to step down, together with turning power over to the Ayatollah Khomeini. Carter’s ignorance as to who would fill the “power vacuum” was specifically what led to the grave situation we have in Iran today. President Mahmoud Ahmadinejad presides over one of the most perilous regimes the world has ever known — who exist for the purpose of destroying Israel and the United States.

In the recent Egyptian crisis, the mass protests endure, demanding an end to President Hosni Mubarak’s 30 year rule. It has become apparent that the result will be a “power vacuum” similar to the one created in Iran 30 years ago.

As much of the world applauds the possibility of a Western democracy, it’s important to acknowledge that few “revolutions” succeed without years and sometimes decades of extreme conflict — especially when such polar opposite parties are positioning for power. Organizations such as THE MUSLIM BROTHERHOOD have goals which harbor establishing SHARIA law throughout the world through world domination and Jihad. The Muslim Brotherhood has been banned from Egypt and will without question fight to fill “the power vacuum” to achieve its ultimate goal.
The Dow ended last week up 2.3% and the SP gaining 2.7% with the Nasdaq composite gaining 3.1% after stocks like JDSU (NYSE:JDSU), Aetna Inc. (NYSE:AET), Tyson foods (NYSE:TSN), all beat earnings estimates and conveyed a positive outlook for  the future.

The markets are paying very little attention to Egypt, instead focusing on what they view to be a continuation of the recent recovery. There is little acknowledgement of the trouble that lies ahead when relying on a philosophy of “blissful ignorance” in regards to Egypt and its impact on the economy.

1-The protests, although large in size, have been relatively peaceful giving investors the feeling that the transition to a democracy will be smooth and without consequence. Who can forget the image of the tank commander embracing one of the protestors? The United States has been sending charter flights to evacuate tourists and the press, leaving Egypt with very few objective journalists to talk about what’s actually happening. We are left to rely on a small number of correspondents for our information.

2-The Obama administration while expressing a need for political reform and having Mubarek step down, seemingly ignores the possibility of an “unfriendly regime” interceding. There is no mention of the threat of having Egypt become a “second Iran”. With a population of approximately 80 million each in Egypt and Iran, the combined opposition will be about 50% of the U.S. population, about 20 times the population of Israel, and can cause a shift to the dominant hostile presence in the Mideast.

3-The Obama administration is not acknowledging the talks held between the banned Muslim Brotherhood and Egypt’s Vice President Omar Suleiman. These talks involve massive concessions to the Muslim Brotherhood as an attempt to prevent a violent uprising. However, these efforts have a high probability of failure, greatly increasing the potential of violence in the region.

4-Investors believe the uprising is a result of the Egyptian people’s desire to become a democracy; however, it’s really food inflation which is the ultimate cause. Fitch Ratings determined food inflation in Egypt to be at 18% and Egyptians blame this on the Mubarek administration. Furthermore, the weak currency policy in both the U.S. and China has resulted in massive inflation, spreading throughout the world — including the US. Inflation will be the single biggest threat to the U.S. economy, the equity markets and the world economy.

Most of the economic and geopolitical  calamities we’ve faced as a nation have been the result of engaging in a policy of “blissful ignorance“, by ignoring “what is” for what we want things to be. The U.S. as a freedom loving democracy wants nothing more than to have our enemies retreat through concessions and eventually become our friends. What could be better than Egypt with its vast resources and Suez Canal to become “just like us”? This will not happen overnight in Egypt and we must have a realistic understanding of the long road ahead.

It is imperative that we abandon our “blissful ignorance” when it comes to the economy and understand the consequences of the inflation which we have played a big role in causing. We must recognize the potential of a massive security threat involving the potential of having “two Irans” as opposed to one.

To contend with difficult times like these, it is not “folly to be wise” and to quote Ronald Reagan, “We cannot play innocents abroad in a world that is not innocent”.

               

Thank You,

Jeffrey C. Sica

President

Sica Wealth Management, LLC

67 East Park Place, 1st Floor

Morristown, NJ. 07960

Tel  973-975-0730

Main  973-975-0750

Fax  973-889-1010