Saturday, August 28, 2010

America Needs a Rival

I've often wondered over the years, why no other country has ever really tried to 'out-America' America. After all, the whole freedom and capitalism thing worked out pretty well for us for a long time. I imagined it might be because nobody wanted to look as though they were sucking up to the top dog. Well, now that America is in a bit of an economic pickle and continues to wander away from free market principals while expanding government at a break neck pace, how 'bout somebody stepping up?

Let's just go ahead and call the race to mediocrity a 38-way tie and get back to trying to out-do each other. A little less civility and a little more fierce competition is what's called for at the moment. Countries within the former Soviet Bloc were able to look to the U.S. and say, 'There is a better way.' Who will our grandchildren point to as they stand in line for their weekly toilet paper ration? Will they come to believe that's as good as it gets?

Yes, the United States is in desperate need of an aggressive competitor in the economic arena. And no, I don't call remaining stagnant for so long that an oppressive dictatorship actually catches up and passes us (China) aggressive competition. That's just pathetic.

C'mon world. This is your big chance.

Monday, August 16, 2010

Where's the Inflation At?

If you were to tell an economist, who had been sleeping in a cave for the past decade or so, that the United States was now $13 trillion in debt, running $1.4 trillion deficits and that the Fed was engaged in “quantitative easing” (creating more money), he or she would likely guess that we also had runaway inflation and sky high interest rates. We don’t, and it’s not because of anything the government’s doing. In fact, although they wont say it out loud, they’d like to see some inflation to help alleviate their debt problem. Instead, deflation now seems more likely. So where’s the inflation?

Inflation is a loss in purchasing power of the dollar. In the past this has occurred when there were more dollars in circulation than the economic activity at the time necessitated. We have an economic slump going on in much of the developed world, but we also have a massive number of newcomers to the world economy who value a buck much more than we do. Their influence seems to be making itself known in the form of deflationary pressure. With today’s technology, goods, services and information travel around the world more frequently and faster than ever before. Most people on Earth live far below the level of income of the average American or European. Even in China, the average annual income is $3,600. It’s much lower in other countries. If you’re running a global corporation, the $5 you take in selling a tall latte in a paper cup can buy you 20 man/hours of labor in some countries. Hence, the competition for dollars among international corporations is still fierce and will remain so as long as this wage disparity exists. That is likely to go on for many many years. Sorry Federal Government. No, inflation for you.

Does that mean our government will collapse under its debt? No. It means the government is going to have to hold its spending level steady or lower it for a decade or decades. Now, if a developing country or two became strong and vibrant enough to create a new currency that was widely accepted across the globe, that could be a game changer. But for the time being, the world is short on currency and that means the value of what’s out there is going to go up (deflation) not down (inflation) even in the face of massive debt held by the issuers. Ultimately, when we get closer to parity in global living standards and wages, countries with massive debts will face hyper-inflation. For now, it looks like that will be a challenge for a later generation.

Thursday, August 12, 2010

Information control is bad economic policy

The Chinese want increased ability to censor Google, Saudi Arabia, the UAE, India and other countries have recently threatened to cut off Blackberry service if they don't get access to encrypted customer information and communication. They claim they need access and censorship for national and regional security. But it could prove to be an economy killer.

Information is perhaps the most closely guarded asset global corporations have. If they can't trust that their information is safe, especially in countries where piracy is already a problem, they may ultimately decide that the risk of losing precious intellectual property is not worth the potential reward of establishing themselves in emerging markets.

Countries and regimes that work too hard to control information may or may not achieve increased security, but they will not achieve increased prosperity in the long run. Entrepreneurs, risk takers, producers will go where the risk/reward equation makes the most sense. Nobody wants to see the fruits of their labor simply taken from them, without warning or compensation. Not even in the name of security.

Governments and by extension the populations that enable them to remain in power, must decide if they want a vibrant economy because their government needs money to enforce control or because they want a higher living standard for individuals within the country. Order and control are not virtuous ends in and of themselves. They can be a consequence of good policy, as a happy and satisfied population can be peaceful and orderly. They are not primary goals. Any idiot with a weapon can impose order. It takes wisdom and leadership to enable and inspire creativity, production, trade and freedom.

Tuesday, August 10, 2010

Too Many Economists Spoil...Everything

Ask 3 or 4 economists what’s in store for us given the national debt, the recession and other current data and you may get 3 or 4 different answers. Why? Because predicting human behavior via a reliable mathematical formula is a pipe dream. People’s behavior changes as their experience, knowledge and awareness changes and the behavior of people is ultimately what economics is all about. There are also opposing forces within our financial system which ebb and flow from day to day, week to week and year to year.

You may have heard the financial collapse in late 2008 caused a “liquidity crisis”. That’s because most of the money we use in every day transactions is not actually Treasury issued U.S. dollars. It’s I.O.U.’s from banks to other banks. The amount of I.O.U.’s any bank can have outstanding is dependent on their deposits and other assets. If someone fails to pay back a loan, it has an exponential effect on the amount of money a bank is allowed to loan out. Your $1 default can cost the bank $10 or more in available cash flow. That’s why a default rate of 5, 6 or 7% can be enough to make a bank insolvent.

The Federal Reserve has attempted to counter the loss in total currency resulting from defaults by engaging in “quantitative easing” which is a cool way of saying “creating money out of thin air”. They don’t even go to the trouble of printing it. It’s just an adjustment to the balance sheet. They use this new money to buy assets like Treasuries and corporate bonds from banks, which gives them more cash, which they can leverage to make more loans using something called the “deposit multiplier”.

Countering the Fed’s counter measures is America’s increased savings rate. As people grow more and more skeptical of our government’s ability to competently manage the nation’s business, they start squirreling away cash. They borrow less and some even horde cash at home, rather than in banks. Remember, the bank can loan out several times the amount of money you deposit, so if you put $1 under your mattress instead of in your bank account, the bank loses several dollars in potential cash flow.

Another factor at work in the economy is the fact that profits from the financial markets have accounted for as much as 41% of corporate earnings in recent years. Financial sector profits come largely from fees on transactions (as does government tax revenues). Fewer transactions means fewer opportunities for fees. Hence both the banks and the government have a vested interest in creating more transactions, whether they lead to any actual added value or not. They view any activity as stimulus, when in reality, much of it is just waste.

Ultimately you create a thriving economy when you give people incentive to work harder and/or smarter to create value for one another. You have to make trade easier and more rewarding at all levels, from individual to small business to mega corporation. Creating more money, more rules and new fees isn’t going to get us there. The best thing the government can do for the economy right now is to quit trying to direct it and just sit back and observe for a while. Trust in the cumulative effect of individual decisions. You’ll be amazed at how efficient it really is.