Monday, December 22, 2014

Oh, USA regarding China, your sincerity is incredible

We are endlessly barraged by comments from lawmakers, pundits, the press, etc. about the problem of the rise of China's economic and military might.  They seem to think that this happened in a vacuum, and is now just appearing without warning.  One wonders where they have been since Nixon's trip?  Could this be one of the most incredible feats of insincere lamenting in history?  Perhaps these same folks haven't noticed that it has been US policy for decades to build up China's technological might by transferring US education, US advanced technology, and US manufacturing companies to China.  How else do they explain the rise of China?

When Nixon visited China in 1972 the economy was that of a large but an unremarkable undeveloped nation with a second rate military.  But, his visit started the opening of trade for which US companies were clamoring.  The mere thought of a billion new consumers and low cost workers must have driven financiers and corporate managers to a frenzy!  They, of course, wasted no time in taking advantage of this new opportunity.  The following decades saw the transfer of thousands of US manufacturing businesses to China, along with their jobs, and just as importantly their technology.  This has likely been the greatest completely voluntary surrender of economic and sovereign capability in history.

The Chinese played this game for all its worth.  They insisted on the transfer of valuable technology in exchange for the right to open manufacturing operations in China.  They also insisted on the formation of joint ventures with Chinese companies in these transferred operations so that Chinese managers and support professional services would rise with the manufacturing capability.  The Chinese, unlike their US counterparts, were working with the goal of increasing the capabilities of the Chinese nation and people.  China sees a greater, endless China as the goal.  US leaders seem to have forgotten about the US as a sovereign, self sufficient nation as the founders had envisioned.  Indeed, given their manifest lack of concern for the future of the US, one wonders who are they working for?

So, now that China has set up advanced universities to teach the next generation state of the art technology and management, built up a modern infrastructure that is the envy of the world, established a broad industrial base, and secured access to a vast amount of world resources, why would anyone be surprised that they take the next obvious step and enhance their military might and presence in the world?  This certainly was inevitable to anyone who wasn't sleeping.

Perhaps this serves a purpose in itself?  China is the new bogeyman for the US to raise the alarm over.  Thus, the US military must rotate to the Pacific to protect US interests in the region from the US created Chinese military.

Perhaps the folks who press this agenda don't see a powerful China as a problem at all?  In spite of saber rattling over disputed islands, and aircraft incursions and encounters, the Alibaba IPO went off without a hitch on the US stock market.  An amazing occurrence if one thinks about this a bit.  Why would a Chinese company want to list on a US market?  Doesn't China have a market?  Doesn't Alibaba need funds in Chinese Renminbi to pay its Chinese workers and debts?  Currencies are now completely exchangeable and fungible in other currencies.  Its like having one world currency where there are no actual sovereign nations ;)

Apparently, as long as the business continues unimpeded and finananciers and corporate managers are making big profits, the effects of manufacturing and job loss, massive trade deficits, and military adventures are mere annoyances and distractions.  So, leaders and pundits, let's stop the lamenting and congratulate each other on "job well done!"  All goals were accomplished, so shouldn't you be celebrating?

Monday, July 7, 2014

What's changed since the start of the financial crisis?

It's been seven years since the start of the financial crisis (an estimate of course as the actual start dates of these kinds of things are always a bit subjective).  We'll take the start of the crisis as being in August 2007 "when BNP Paribas terminated withdrawals from three hedge funds citing "a complete evaporation of liquidity"[1].

What has changed?  For the better?  For the worse?  Or not at all?

US National Debt:  This certainly has gotten worse.  In August 2007 it stood at:$8.9trillion but by June 2014 it had ballooned to: $17.5trillion [2].  That's almost double the amount in only seven years!  So, what did Uncle Sam spend our money on during that period?  Well, a big part of it turns out to be bailing out the banks.  As of 2011 the total amount of funds disbursed by the government to the banks was: $4.76trillion [3].  Most of the rest was due to continued government spending during a time of economic depression that lowered tax receipts.  In essence the government was hit with a double whammy by the crisis in that it had to keep spending through running deficits and it chose to bail out the major banks which were almost certainly going to otherwise fail.

Labor:  No improvement here.  Participation rate is still headed down, and the employment/population ratio which plunged during the official recession period has hardly budged at all  [4].
So, all those folks who lost their jobs don't appear to be back in the labor force.  Of course, that's only a problem for these folks if they say its a problem.  If they took early retirement or are happy to be out of the labor force then this is OK.  But, I suspect that many in this group are out of work involuntarily and would like to get a good job.  For these folks the depression continues.  In May 2014, 3.4 million were long-term unemployed and 7.3 million were involuntarily part-time employed [9]. Fortunately for the national debt, the wise people in Washington decided to end the long term unemployment benefits for many of these non-workers.  Not so good if you're on the receiving side.

Stock Market:  The S&P 500 was $1433.06 on July 30, 2007 and is trading around $1977 as of this writing on 7/1/2014.  The bailouts certainly helped the markets, particularly since the S&P500 hit a low of $683 after the crisis began.

Regulation: The main government regulatory response to the crisis was the passage of the Dodd-Frank Act which imposed some minor requirements on banks.  In addition, greater capital requirements were imposed on banks, a designation of "systematically important" was created for the biggest banks, and some form of plan for an orderly liquidation was to be created for these banks [5].  But the overall response was quite limited given the enormity of the crisis.  Nothing on the scale of the response to the Great Depression was even under consideration.  No "Pecora Commission" was created to properly investigate the causes of the crisis.  Few were brought to account for their actions.  In other words, other than an increased requirement for reserve capital, banks could pretty much go back to what they were doing before the crisis.  Though their actions will certainly come under greater scrutiny than before, and their apatite for risk is slightly diminished, at least until they can find ways of once again shifting the risk to other parties.

Trade: Once seemingly bright spot in this is that the trade deficit dropped from the pre-crisis level of $-705billion in 2007 to a low of $-383billion in 2009 and was $-476billion in 2013. Interestingly, exports actually grew over this period, with the exception of one year, from $1.65trillion in 2007 to $2.28trillion in 2013.  Total trade has expanded dramatically from $4.0trillion in 2007 to $5.0trillion in 2013[7].  So, the crisis has been good for trade.

Housing: As usual, Bill McBride has collected some great data and created some useful graphs.  The Core Logic Housing Price Index peaked at around 200 in 2006 before the crisis began, or perhaps a better description is that it is part of what tripped the crisis release mechanism, bottomed in 2011 to 2012, but has been moving up for the last several years. 
Is this good or bad?  Well, depends on which side you're on.  If you are a homeowner with a big mortgage or a seller then this is good, if you're a buyer then this is bad.  More importantly is the "rentier" aspect of home prices.  That is, what fraction of the price represents actual construction costs, and what fraction represents aspects of speculation?  That is, the price of the land and price of older buildings?  A market that is good for homeowners is one where the land is essentially free and the price of the house almost entirely represents construction costs.  The fraction of home price that is land rose from 32% in 1984 to 50% in 2006 [10], a clear indication of the speculative boom in housing, and incidentally, evidence that the Fed was quite aware of this.

Once significant improvement in the housing market is the fraction of mortgages that are seriously delinquent has dropped dramatically from the high in early 2010 and continues downward.  A simple extrapolation shows that by the beginning of 2016 this rate should be back to pre-crisis levels.  This is an indication that homeowners are getting their finances back into order.

What does this mean for the future?  What's there to prevent another crisis?  The supporters of current policies believe that the added regulation and reserve requirements are sufficient to prevent another catastrophe like the crisis we're still digging out from.  I'm less sure as many of the same risky behaviors that caused the crisis are now rearing their ugly heads once again [8].  The rules of the game determine the play.  And the rules of this game have shifted dramatically over the last few decades to allow risky financial behavior by banks, businesses, and consumers that previously was considered unacceptable.  The inevitable outcome is the ongoing financial crisis.  A return to the regulations and policies which led to decades of growth and stability is a prudent action for the future of the nation.

[7] See table on:

Thursday, April 3, 2014

The "death tax" is as American as apple pie

The estate tax, or "death tax" as its critics call it, is an essential aspect of the American republic.  Indeed, it's an essential aspect of any republic.  Recall that essential means something can't exist without whatever is that essential thing, which is exactly what I mean; a republic cannot exist for long without a meaningful estate tax.

Several premises of the American republic were: that the aristocracies of Europe were not serving the interests of the vast majority of the people, and that the people have inherent rights that are not being recognized by the ruling class of aristocrats.   That the people were capable of governing themselves and only through this self government were the people able to ensure that their rights were defended.

Now what exactly is an aristocracy?  To the casual observer it appears that it is a system of interrelated families that have members who have titles which grant them a certain status.  And that the members inherit these titles at birth, so you have to be born into the system.  That's a pretty closed system.  These are all true, but are really not the foundation or the causes of the aristocracy, rather these are the symptoms.

An aristocracy is primarily a system of inherited wealth.  Wealth brings power and influence, so that those with great wealth have much of both, and when they band together their share of both grows markedly.  This group, by necessity, is a very small fraction of the population, perhaps less than 0.01%.  This very small group wields enormous control over the lives of the rest of the population.  This group may not act in the best interests of the majority of the population, so some rational for the legitimacy of their actions needs to be enacted.  That mechanism is the idea of hereditary aristocracy.  A system which cannot be breached from the outside due to its inherent closed nature.  Thus, the population is led to believe that the right of the aristocracy to rule is natural and permanent.  But of course it's not.  Each title and ceremony and right were crafted by those in power to solidify their power, so much so that they appear to be an essential part of the the state.

What do the rest of the population think of this?  Inevitably, the aristocracy will take actions that will disadvantage the rest of the population.  Some of the people will recognize this and be unhappy with the situation.  They will band together and take action when the opportunity arises to change the situation.  The American revolution was just such an opportunity.  The result was a republic "of the people, by the people, for the people".  The challenge then is to prevent the formation of a new aristocracy that can overturn the republic.

The key to preventing the formation of a new aristocracy is to prevent the passing down of inherited wealth from generation to generation.  That is, to prevent the creation of what people rightly call dynasties.  The very word dynasty refers to an aristocratic structure.  So what is the best way to prevent the passing of great wealth and the formation of dynasties?  The inheritance or estate tax.

This single essential need, of preserving the republic, is rationale enough to defend the estate tax from the endless challenges of those who think it unfair, or big government, or punishing success, or whatever other argument du jur.

So, I repeat, a meaningful estate tax that prevents the passing of great fortunes from generation to generation is an essential aspect of a republic.  

Saturday, March 1, 2014

"Fordism" used to be the norm

"Fordism" is the economic philosophy that widespread prosperity and high corporate profits can be achieved by high wages that allow the workers to purchase the consumer goods they produce, such as automobiles, furniture, clothes, etc.  Named for its creator and biggest proponent the industrialist Henry Ford, who understood the paradox of workers producing goods that they could not afford themselves, which was the prevalent state of the economic system in the US when Ford started his automobile production.  Ford understood that such a system is self-limiting in that the few who had all the wealth could not possibly spend it all, thus the distribution of work product, i.e. the goods and services produced, would progressively shift to an overall inefficient application of labor and resources, and a state of perpetually high unemployment would exist.  Fordism also includes the shift to specialized mass production which made for large quantities of inexpensive goods that appeal the the worker rather than the luxury buyer.  But mass production also brought undesirable working conditions of intense concentration to the work and at the same time boredom.  Conditions which made these jobs hard to keep properly filled.

Without Fordism, there would not be the production of large quantities of middle class goods and services such as small homes, economical cars, reasonable furniture, home goods, clothes, and food.  Instead, the production would shift to small amounts of esoteric luxury items and services for a tiny fraction of the population, where each item or service took significant labor to produce.  These are things like elaborately ornate embroideries, and home finishes which require hand applied elaborate details, watches meticulously crafted by hand, extreme luxury and performance cars, exquisitely prepared meals at exclusive restaurants, and services like personal chefs, legions of gardeners, house keepers, butlers, etc. to maintain immaculately manicured homes.  In other words, fewer customers for Ford's cars and for the myriad of other mass produced goods from the factories of America.  However, Ford was no opponent of luxury and fine goods, rather he thought that there was a limit to the need for these and beyond this limit they became harmful to the greater economy.

Employers benefit from Fordism in two ways, first, with high wages the employer has the pick of the most stable and most efficient employees, resulting in high productivity, high quality work, and low turnover.  Secondly, the workers earn more income than previously, so they can purchase more goods and services at higher prices, the very goods and services which they produced, resulting in increased sales for the employer.  This results in a virtuous cycle of rising incomes, motivated workers, low unemployment, and rising consumption driving rising sales and profits.

Fordism is a formula for maximal employment and having the economy functioning at its expected potential.  Indeed, Fordism raises the expected potential of the economy faster than it would have risen otherwise because the incessant demand it creates induces producers to increase productivity through efficiency and innovation faster than they otherwise would have attempted.  Producers are forced down this path of growth because no other path is available to meet the demand.  In other systems, there is no increase in demand as efforts of employers are aimed at reducing wages which allows for a greater profits at the same price, and the belief that more workers could then be hired to meet demand at the same price.  But this reduction in wages does not increase demand as the total amount of wages is the same.  It simply means that the workers share the same amount of goods as today, but have fewer per worker.

Fordism is a nationalist system, therefore it has one problem.  It needs to be all encompassing at the national level.  All entities which interact in the system must be susceptible to the principles of Fordism for this system to work.  Fordism could be a global system, but all nations must adopt its principles for this to happen.  At the national level this can be ensured by two necessary mechanisms; first, all regions of production must come under the same rules and opportunities as existed in the Midwest manufacturing belt where Fordism started.  This is what happened all over American as production expanded through the mid-twentieth century.  Manufacturers in the West, East, and South were forced to adopt Fordism or lose their workers to those who did.  The second is to enforce a balance of trade with other nations and to provide for the protection of high wage, high tech, high value added industries.  This is what happened in America until the mid-1960s, which is coincidentally when problems in the US economy and financial situation started to occur.  And this is what Germany does today, which helps explain its thriving production economy.

Starting in the early 1970s, the US abandoned Fordism by shifting to globalization.  Globalization is by definition anti-nationalism.   This shift promoted unbalanced trade which left massive trade deficits of unsettled trade accounts, and free-floating currencies which were no longer backed by real goods and services (the abandonment of Bretton-Woods in 1971).  The result was that goods were imported from foreign nations where wages were kept artificially low compared to the US through currency manipulation and a lack of trade settlement.  US manufacturing jobs which relied on Fordism's high wages were shipped overseas.  Wages fell in the US and the standard of living of Americans with it.

Therefore, it is highly likely that resurrecting traditional American trade policies will lead to a similar resurrection of Fordism and the American standard of living.

PS  Apparently Fordism is making a bit of a comeback.  Here's a quote from a recent article by Robert Reich [1]

"For one thing, a higher minimum wage doesn’t necessarily increase business costs. It draws more job applicants into the labor market, giving employers more choice of whom to hire. As a result, employers often get more reliable workers who remain longer – thereby saving employers at least as much money as they spend on higher wages.

A higher wage can also help build employee morale, resulting in better performance. Gap, America’s largest clothing retailer, recently announced it would boost its hourly wage to $10. Wall Street approved. “You treat people well, they’ll treat your customers well,” said Dorothy Lakner [2], a Wall Street analyst. “Gap had a strong year last year compared to a lot of their peers. That sends a pretty strong message to employees that, ‘we had a good year, but you’re going to be rewarded too.’



Friday, February 28, 2014

Adam Smith - Sovereignty more important than wealth

This next post on Adam Smiths writings is in regards to the needs of defense of national sovereignty when it is in conflict with free trade.  In Wealth of Nations, Smith says "As defence (sic), however, is of much more importance than opulence, the act of navigation is, perhaps, the wisest of all the commercial regulations of England."[1]  Here "defence" is the defense of England against military action by foreign nations.  The "act of navigation" is a trade law which restricts the importation of goods to England which are not carried on English crewed, English owned ships.  The immediate goal of the act was to promote the British Navy by having a large standing source of English ships and crew, and to disfavor the Dutch who previously had a large commercial fleet which enabled a large naval threat to England by the Dutch.

The opulence is what Smith believes to be the natural result of free trade.  He says "The act of navigation is not favourable to foreign commerce, or to the growth of that opulence which can arise from it."  This is, under certain conditions, true, but under others not so true, at least not for the general population of the nation.  It is certainly true for the traders engaging in the commerce of who's welfare Smith was highly concerned.

What is most important in the first quote is that Smith implies that national sovereignty is more important than free trade, and that nations have a right to protect their sovereignty.  Actually he says "much more important" as if that need to protect the nation overrides all trade concerns.  That is, even Smith agrees that there are limits to free trade.  And that due to the effects of free trade which endanger the existence of a nation, for nations were continually engaged in existential battles back in those days in which a country could be conquered and come under the domain of another nation, nations are rightfully and reasonably allowed to place restrictions on free trade.

Smith here means defense against military threat, but that leads one to ask if other threats to the nation are also covered by this sentiment?  Western nations are rarely the target of military invasion these days, but threats to their existence continue to take place in other forms, most often economic, political, and cultural.  If there are forces due to free trade that are harming a nation, shouldn't it have the right to act to prevent these corrosive effects just as Smith insists that a nation has the obligation to inhibit free trade in order to protect itself militarily?  Isn't this protection of the nation much more important than supposed opulence?  Opulence which in other posts has been shown to be rather unevenly distributed in a nation and may overall make that nation poorer while enriching only a few.

How would free trade be regulated today?  Much like back in the day when Smith wrote, regulation would happen today through the use of import tariffs and quotas.  If a nations unemployment is high, its manufacturing base, which is the basis of trade, is declining due to production moving off shore, if high wage, high tech, high value added jobs are moving off shore due to free trade, shouldn't a nation defend itself?  Just as it would defend itself against the same economic damage if it was caused by a military conflict?

It seems that the pertinent feature of Smith's sentiment is that the damage done to a nation should determine the action taken, rather than the specific mechanism by which that damage is inflicted.  Damage is damage regardless of the source of the damage to a nation.  And the proper response is to take actions to protect against the source of that damage.  If that damage is due to free trade, then that trade needs to be restricted in the interest of the continued existence and welfare of the nation.


Saturday, January 4, 2014

Labor is wealth - Adam Smith

"Labour, it must always be remembered, and not any particular commodity, or set of commodities, is the real measure of the value both of silver and of all other commodities." and "The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired it and who wants to dispose of it, or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people." Adam Smith, Wealth of Nations [1]

I've been reading Adam Smith lately because so much of the school of economics which is popular these days is based in large part on his work.  I also suspect that many who preach the gospel of Adam Smith have actually never read his work.  So, I'm going to produce a series of posts based on this work, with this being the first.

Smith says a great many things.  Some of which are a bit disturbing to modern sensibilities, such as his appraisal of the laboring class (of which he is clearly not a member) as a flexible commodity which expands and contracts as circumstances allow.  His comments may be on the mark, but the deafness to the state of the human condition is quite marked in his writings.

The topic today is wealth and labor, and in Smith's quotes above is where I think that he really get's it right, that all wealth is ultimately expressed as its cost in labor.  So, let's look at these in detail.

"The real price of every thing,..., is the toil and trouble of acquiring it".  That is getting something takes some effort or labor.  Labor takes time and effort, if even a small amount that may not seem worth tracking.  Any thing put into your hands for your use took some amount of labor to get it there.  Take for example a wood chair produced by a carpenter.  The carpenter needs to sit, so he needs a chair.  This chair will not just appear out of thin air and into his house by simply wishing for it.  The carpenter must do some labor on some wood with his tools to produce the chair.  That is, the carpenter gives up some amount of his time and associated effort to get that chair.  The time spent working on the chair is lost forever to be used for some other purpose.  The chance to do something else, or nothing at all, is gone by making the chair.  But, without this labor, there simply is no chair, no matter how much he wants one.  Thus "the real price" of the chair was the labor that the carpenter put in to produce it.  Even if you lived in the Garden of Eden with Apple trees everywhere, acquiring that apple to eat took some labor.  You had to get up, walk to the tree, reach up, and pick the Apple.   That was "the real price" of the Apple.

Once the carpenter has a chair, perhaps he makes another, because he knows others want to sit as well, with the intention of trading it for some other good.  Perhaps he wants a wood table to go with his chair.  Perhaps he could make the table but prefers to make chairs as he is talented at it.  Maybe he can get one table in exchange for one chair, but if he made the table himself it would take the time he would use to make two chairs.  Thus what the table "is really worth" to the carpenter is "the toil and trouble which it can save to himself" by making a chair in half the time of making a table, and "which it can impose upon other people" by having another make the table and exchange it for the chair.  In this case making the chair is worth it to the carpenter to trade for the table because he saved his labor that way.  The table "is really worth" one chair to the carpenter.  But if no trade for a table could be made, then the carpenter would have to decide if making the table is worth the labor, or if he would rather go without, as the table "is really worth" two chairs in this case.  In the other extreme where making a table only takes half the time as making a chair, then clearly the carpenter should make the table himself, as the table "is really worth" only half a chair.

Contrast this insight of Adam Smith with those on Wall St. who claim that they can create wealth without labor, simply by financial machinations.  For instance, David Einhorn of Greenlight Capital proposed some financial modifications to Apple computer corp's financial operations to "unlock hundreds of billions of dollars of latent shareholder value".[2]  As if this value didn't already exist and he, by this action, would create it.  Not everyone has fallen for this trickery.  For instance, Aswath Damodaran of Columbia University said "There will be NO value created..none". [3]  No new goods would be created, either now or in the future, by the proposed change.  No more iPads or iPhones would be produced.  No more iMacs or apps would be created.  The only change would be shifting of financial resources from one place to another.

Adam Smith similarly notes that money, that which holds value for transactions, does not in and of itself contribute any value to an economy, rather it forms the means of transaction of goods in an economy.  " money, by means of which the whole revenue of the society is regularly distributed among all its different members, makes itself no part of that revenue. The great wheel of circulation is altogether different from the goods which are circulated by means of it. The revenue of the society consists altogether in those goods, and not in the wheel which circulates them. In computing either the gross or the neat revenue of any society, we must always, from the whole annual circulation of money and goods, deduct the whole value of the money, of which not a single farthing can ever make any part of either."  In other words, financial mechanisms only are useful in transferring real value, but no amount of financial machinations can ever create value.  No one values money, or any financial asset or security, for itself.  Rather we value these things for the goods (and services) which they can purchase.  Behind every money or financial asset must be some good (or service) of real value that backs it up.  In Adam Smith's writings, money is the physical precious metals or coins made from these.  The idea of fiat money is not in Wealth of Nations (at least not as far as I've read so far ;).  But the idea that all real value is composed of goods (and services) and that the cost of labor of creating these is "the real price" of all is firmly established therein.

I am continually amazed that the financial wizards who conger up exotic financial instruments like derivative securities, and the idea of valuing them through complex models, nonetheless revere Adam Smith as one of the founder's of the popular school of economics which they so vociferously uphold.  Would Smith approve of these modern day financial machinations?  Although it is impossible to know for sure, his writings seem to suggest that he would be most mortified by their existence, and amused by the gullibility of the public and it servants in accepting these as legitimate financial mechanisms.